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Cash Balance Plan Summary

Introduction to Cash Balance Plans

Cash Balance Plans are a type of tax-qualified Defined Benefit Pension Plan. They have increased in popularity in recent years for several reasons:

  • Tax Benefits – Contributions to the Plan are tax deductible and the investment return is tax deferred.

  • High Contribution Limits – Cash Balance Plans permit larger annual tax-deductible contributions and benefits than is possible with a 401(k) Profit Sharing Plan. 

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  • Flexible Design – Cash Balance Plans can be designed to provide age neutral benefits to all employees or targets allocations to specific individuals. 

  • Easy to Understand – Cash Balance Plans are easier for plan sponsors and participant to understand than traditional Defined Benefit Pension Plans. 

  • Combine with Existing or New 401(k) Plan – Cash Balance Plans do not require substantial changes to existing 401(k) Profit Sharing Plans and work well combined with 401(k) Profit Sharing Plans. 

Cash Balance Plan Features

1. Niche Retirement Plan – Cash Balance Plans are a great retirement plan solution for physician groups, dental groups, and other professional practices. They also work well for other small business owners or self-employed individuals.

2. Tax Deductible Contributions – Cash Balance Plans are tax qualified retirement plans like 401(k) Plans. The contributions made to Cash Balance Plans are tax deductible and the investment earning are tax deferred. Cash Balance Plan assets are not subject to income tax until withdrawn from the Cash Balance Plan or a rollover IRA.

3. High Contribution Limits – Cash Balance Plans provide much higher tax-deductible contributions than a 401(k) Profit Sharing Plan alone can provide. The maximum Cash Balance contribution amount is dependent upon an individual’s age and increases as the individual ages. At all ages, the total maximum contribution available is always higher with a Cash Balance Plan than with a stand-alone 401(k) Plan. 

4. Creditor Protection – Cash Balance Plan assets are ERISA creditor protected. 

5. Flexible Design – Cash Balance Plans can provide for different benefit levels for individual owners, physicians, partners, and other key individuals. 

6. Supplement to 401(k) Plan – Cash Balance Plans can be maintained along with and as companions to 401(k) Profit Sharing Plans. 

7. Benefit Defined in Plan Document

a) The Plan document describes the annual allocations and the interest crediting rate.

b) The annual allocations earn interest gains at the interest crediting rate. The interest crediting rate is usually a fixed rate between 3% and 5%. Cash Balance Plans can have a variable interest crediting rate tied to the plan asset return or a market-based index. Variable interest crediting rates may decrease the maximum lump sum benefit limits for target employees, increase employee contribution costs, and complicate the non-discrimination testing. For these reasons, a fixed interest crediting rate is preferred.

c) The total value of plan assets will differ from the total value of Cash Balance benefits.

8. A Smarter Defined Benefit Plan – Cash Balance Plans are a type of Defined Benefit Pension Plan. Cash Balance Plans are an improved version of Defined Benefit Pension Plans are preferable for several reasons. 

a) Communication – The benefits in a Cash Balance Plan are valued as lump sum account balances. Traditional Defined Benefit Plans value benefits as single life annuities. It is easier for a participant to understand their benefit value in a Cash Balance Plan.

b) Age Neutral Benefits for Employees – Cash Balance Plans can provide the same contribution rate to employees. This was not possible with traditional Defined Benefit Plans and often resulted in unfavorable contribution costs for certain employees.

c) Increased Flexibility – Cash Balance Plans provide more flexibility than traditional Defined Benefit Plans when it comes to allocations and contribution amounts. 

d) Consistent Benefit Growth – The benefits in a Cash Balance Plan grow at a plan defined interest crediting rate. Cash Balance Plan benefits are not subject to volatile changes in value due to interest rate environment changes like the benefits in traditional Defined Benefit Plans were. 

9. But still a Defined Benefit Pension Plan

a) Cash Balance Plans are subject to annual Actuarial Valuations and Certifications by an Enrolled Actuary.

b) Cash Balance Plans are subject to minimum funding requirements. This does not mean that contributions are necessarily required each year, but Cash Balance Plans do not have the same contribution flexibility as Profit Sharing Plans.

c) There are a range of available contributions each year from a minimum required contribution to a maximum deductible contribution.

10. Pooled (Trustee Directed) Investment Account – Since Cash Balance Plans are Defined Benefit Pension Plans, the benefit amounts are defined in the plan document and are not dependent upon the plan’s asset return. For these reasons, Cash Balance Plans utilize trustee directed accounts rather than participant directed accounts. 

11. Contribution Flexibility

a) An annual range of available contributions from minimum required to maximum deductible. 

b) The plan sponsor can amend the plan up until 2.5 months after the plan year-end (March 15th for calendar year plans) to increase benefits and funding range. 

c) The plan sponsor can freeze plan or amend to lower benefit allocations before participants work 1000 hours during a plan year (generally around May or June for calendar year plans.) 

d) Note, in most cases a plan sponsor is not required to fully fund a Cash Balance Plan. Upon Plan Termination, the non-owner participants must receive the full value of their benefits. However, a majority owner of the plan sponsor can receive a lower distribution amount based upon remaining plan asset amount in lieu of full funding their benefit amount. 

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