What is a Cash Balance Pension Plan?
A Cash Balance Pension Plan is technically a defined benefit plan but operates similarly to a defined contribution plan. It establishes a hypothetical account for each participant, which grows annually through employer contributions and interest credits. Unlike traditional defined benefit plans, the benefit is stated as an account balance rather than a monthly income stream. This structure allows participants to see their retirement savings grow in a more transparent and predictable manner.
How Do Cash Balance Plans Work?
Contributions
Contributions to a Cash Balance Plan are determined by a formula specified in the plan document, which can be a percentage of pay or a flat dollar amount. Additionally, an annual interest credit is applied to each account, usually based on the yield of a 30-year Treasury bond, which has been around 5% in recent years. This formula ensures that contributions are consistent and predictable.
Interest Credits
The interest credits are guaranteed and do not depend on the plan’s investment performance. This ensures a predictable growth of the account balance each year, providing stability and reliability for participants.
Account Management
Each participant’s account is maintained by the plan actuary, who generates annual statements showing the account balance and any changes. This regular reporting helps participants keep track of their retirement savings progress.
Benefits of Cash Balance Plans
High Contribution Limits
Cash Balance Plans allow for significantly higher contributions, often exceeding $300,000 annually for some participants, especially those over 60. These plans can be coupled with defined contribution plans like 401(k)s to compound retirement tax benefits. This makes them particularly appealing to older business owners who want to catch up on their retirement savings.
Tax Advantages
Cash Balance Plans are IRS-qualified, meaning all contributions are tax-deductible expenses for the employer. The plan assets are also protected from creditors, providing a secure ‘nest egg’ for retirement or to pass on to heirs. The tax-deferred growth of these plans further enhances their appeal by allowing participants to grow their savings without immediate tax liabilities.
Portability and Flexibility
Cash Balance Plans are portable, allowing participants to take the vested portion of their account balance with them if they change jobs or retire. Participants can opt for a lump sum, an annuity, or roll the balance into an IRA, offering flexibility in how they choose to manage their retirement funds.
Contributions and Funding Requirements
Contribution Flexibility
While contributions can be different for various participants, any changes to contribution levels must be made through plan amendments. These amendments must be done before any employee works 1,000 hours in a plan year or within two and a half months after the end of a plan year. This flexibility allows employers to adjust contributions based on business needs while ensuring compliance with regulatory requirements.
Funding Requirements
Cash Balance Plans must meet specific funding requirements and comply with regulations to maintain their qualified status. This includes ensuring that the plan assets are sufficient to cover the promised benefits, which helps in maintaining the financial health of the plan.
Withdrawals and Distributions
Distribution Options
Participants can choose from several distribution options: a lump sum payment, an annuity, or a partial distribution. If the account value exceeds $5,000, participants must also be offered the option of an annuity. This variety in distribution options allows participants to select the method that best suits their retirement goals.
Rollover Options
Participants can roll over their account balance into an IRA or another qualified retirement plan, allowing them to defer taxes and continue earning tax-deferred interest. This option provides additional flexibility in managing post-retirement finances.
Comparative Statistics and Popularity
From 2001 to 2020, the number of Cash Balance Plans increased 15-fold, from 1,477 to 22,657. These plans now account for almost 50% of all defined benefit plans and hold over $1.2 trillion in assets. This significant growth underscores their increasing popularity among business owners and small businesses seeking robust retirement savings solutions.
