Cash balance plans: The right solution for the right plan sponsor
October 18, 2023
In recent years, traditional pension plans have become less common and defined contribution plans have grown in popularity.
To help clients maximize their retirement benefits, cash balance plans provide an alternative to traditional pension plans. Cash balance plans combine the best benefits of traditional pension plans and defined contribution plans.
While cash balance plans offer many benefits, they may not be right for all plan sponsors. We will answer common questions about cash balance plans to help determine whether they are a fit for your client’s business and their employees.
What is a cash balance plan?
A cash balance plan is a hybrid retirement plan in which the employer contributes a calculated amount on behalf of each eligible employee.
- The account earns a projected rate of return.
- The employee will gain access to their projected benefit at the time of a qualified distribution or upon retirement.
- The recipient may receive their benefit as a lump sum or may transfer the amount to another group retirement plan or IRA as allowed by the plan document.
How do cash balance plans differ from 401(k) plans?
Unlike 401(k) defined contribution plans, which depend on funding from employee contributions, cash balance plans do not require workers to designate a portion of their salaries to the plan. In that way, they are similar to traditional pension plans.
Cash balance plans are managed by a third party administrator (TPA) in partnership with a financial professional. The employer bears the investment risk, not the employee. In other words, any losses or gains do not directly affect the projected benefit amount the participant is entitled to receive.
And unlike 401(k) plans, which are not federally insured, cash balance plans are treated like traditional defined benefit plans. They are typically insured by the Pension Benefit Guaranty Corporation (PBGC). If a defined benefit plan is terminated without sufficient funds to fulfill its stated benefits, the PBGC may assume trusteeship and pay the benefits within the law’s limits. Cash balance plans are also protected by ERISA regulations.1
How do cash balance plans differ from traditional pensions?
Both a traditional pension plan and a cash balance plan offer guaranteed employee benefits. Unlike traditional pension plans that begin payments at retirement, a cash balance plan offers each covered employee a specified lump sum “cash balance” benefit at retirement. Cash balance plans may also offer higher contribution limits than traditional pension plans.
Which businesses are suited for cash balance plans?
Cash balance plans may not be appropriate for all organizations. Generally, businesses that are consistently profitable and have predictable cash flows are a good fit, such as lawyers, doctors, engineers, accountants and consulting firms.
Profitable sole proprietors and family-held businesses may also be a good fit, in addition to businesses that have maxed out the contribution limits with their defined contribution plans.
Can employers offer both a cash balance plan and a 401(k) plan?
Yes, a cash balance plan can be paired with a 401(k) plan. Some employers offer a cash balance plan for their executive teams, owners, highly compensated employees, or key employees in addition to a 401(k) plan, while offering only the 401(k) to the rest of their workforce.
Why offer a cash balance plan?
Cash balance plans may provide additional incentives for companies to attract or retain key employees and/or potential recruits. For example, cash balance plans allow for higher contribution limits than 401(k)s and pension plans, providing greater potential for growth over time.
There may also be tax benefits for both the employer and employees. Employers may be able to deduct plan contributions as a business expense, and employees can defer taxes on contributions and earnings until retirement.
SOURCE
1 Department of Labor, Frequently Asked Questions on the Cash Balance Pension Plans Compliance, accessed September 20, 2023
