Cash balance plans made simple

A cash balance plan is considered a defined benefit plan but has many characteristics of a defined contribution plan.

Cash balance plans allow key employees to receive substantially higher tax-deferred contributions than allowed under only a defined contribution plan (ex: 401(k)).

• Professional service firms (medical, CPA, legal, engineering).
• Organizations with executives and highly compensated staff looking to save more for retirement.
• Established organizations with consistent profits and cash flow.

Pros:

• Tax savings from deferring under a qualified retirement plan
• Lower investment advisor fees compared to saving on your own
• Convenience of saving in a retirement plan versus on your own

Cons:

• Added complexity
• Added costs:
  • Actuarial/administrative costs
  • PBGC premiums (if any)
  • Increased retirement contributions

There can be substantial tax benefits to shareholders funding a cash balance plan. The annual amount reduces taxable income dollar-for-dollar. The investment earnings grow tax-deferred similar to a 401(k) plan.

• An annual employer contribution/credit is added to each participant’s account balance, either a percentage of income or fixed dollar amount as defined in the plan document.
• An interest credit is also added to the account balance each year. The interest credit may be a fixed rate (for example, 6%) or a variable rate (for example, the actual return on plan assets).
• The vested account balance is typically the benefit payable upon termination of employment, with the option to convert to an annuity.

Typically, a cash balance plan works alongside a 401(k) plan and does not replace it. Employees may receive a higher proportion of their benefit in the 401(k) plan and the key employees receive a higher proportion of their benefit in the cash balance plan.