Why A Business May Consider Adopting A Cash Balance Plan?
There are two general types of pension plans, defined benefit (“DB”) plans and defined contribution plans (such as “401k plans”). In general, DB plans provide a specific benefit at retirement for each eligible employee, while 401k plans specify the amount of contributions to be made by the employee and employer toward an employee’s retirement account. In a 401k plan, the actual amount of retirement benefits provided to an employee depends on the amount of the contributions as well as the gains or losses of the account.
A cash balance (“CB”) plan is a specialized DB plan that defines the benefit in terms that are more characteristic of a 401k plan. In other words, a CB plan defines the promised benefit in terms of a stated account balance.
Many businesses (for example, professional practices) are funding their 401k plans so that the owner/professionals are “maxed out” at the 401k plan limits. Under such a plan, the Tax Code limits the compensation that each participant may defer (“elective deferrals”) for a year (i.e., $19,000 for 2019) as well as the overall contributions (elective deferrals and employer contributions) that may be allocated to a participant’s account for a year (i.e., $56,000 for 2019). Additional elective deferrals (“catchup contributions”) may be made by a participant who is at least age 50 (e.g., an additional $6,000 for 2019).
Under a CB plan, however, the limits are based on the benefits that may be paid by the plan at “normal retirement age”. The maximum benefit that may be paid upon retirement (usually age 65) to an owner/professional generally is the value of a life annuity in the amount of $225,000 per year (for 2019). (The dollar limit is reduced if the “normal retirement age” under the plan is less than 62 or if the participant does not have at least 10 years of participation in the plan.)
As a plan for which the maximum benefit is based on the maximum amount which can be paid at normal retirement age, rather than the amount that is contributed to fund that benefit, a CB plan may be designed so that the annual contribution allocation for a participant in the CB plan far exceeds the $56,000 or $62,000 annual contribution limit for a 401k plan. Furthermore, in many cases, it is possible to simultaneously participate in the 401k plan up to the maximum $56,000 or $62,000 level and participate in the CB plan at the maximum benefit level.
Depending on the demographics of the group (e.g., the ages, compensation levels, and the numbers of owners/professionals and the other employees/staff), it may be possible to design a CB plan that provides for very high levels of “contributions”, benefitting the owners/professionals much more significantly than other employees. Alternatively, it may be possible to have different levels of “contributions” for different individuals, with older owners/professionals receiving much greater contributions than younger owners/professionals and staff.
ACSI has the expertise to explain the advantages and disadvantages of CB plans, advise about plan operation, and analyze the demographics of a business to determine if a cash balance plan is a good fit.