Cash balance plans are growing in popularity, with more business owners giving some consideration to offering them as a retirement plan option. According to the 2018 National Cash Balance Research Report, the number of new cash balance plans has increased 15%, while new 401(k) plans have only increased 1%. In fact, cash balance plans now make up 37% of all defined benefit plans, compared with just 2.9% in 2001.
A cash balance plan is a hybrid pension plan, combining features of a defined contribution and a defined benefit plan to provide employees a guaranteed income upon retirement. With these plans, an employer sets aside a percentage of each employee’s yearly compensation (plus interest), placing these funds into a hypothetical retirement account the employee monitors.
They may seem complex, but cash balance plans are a great retirement plan option for businesses. To help you gain a better understanding, we’ve answered 5 frequently asked questions about cash balance plans below:
How are cash balance plans funded?
Unlike defined contribution plans, cash balance plans do not rely on employee contributions. Retirement funds are contributed through many investments selected by the plan sponsor. Participant accounts are credited in two ways – benefit credits (based on pay, age or service), and interest credits (determined by applying an interest crediting rate to participants’ cash balance accounts).
How are benefits paid or distributed?
Cash balance plan participants are guaranteed a pre-defined benefit upon retirement, distributed through annuity payments or one lump-sum payment.
Are cash balance plans portable?
Similar to most defined contribution plans like a 401(k), cash balance plans are portable. This means that employees can take benefits or accumulated assets with them when they leave their current employer or switch jobs. More specifically, portability allows participants to transfer the funds directly to their new employer's retirement plan or to an IRA.
What are the advantages of cash balance plans for employers?
Beyond the obvious benefits that employees receive by participating in a cash balance plan, this option also has clear advantages for employers, including:
Ease of communication: It is very easy to communicate to employees how this works, as it usually guarantees a specific rate of interest on contributions. Because the benefit has a dollar amount, it allows employees to track their funds in a simpler and more reliable manner.
Tax savings: Cash balance plans offer tax savings for employers because they are IRS-qualified plans. This means that all contributions to qualified plans are tax-deductible expenses and the assets are protected from creditors.
Higher contribution limits: They offer higher contribution limits than traditional defined contribution plans, which is an incentive for both employers and employees who need to build their savings for retirement in a short period of time. They get to contribute and accumulate more than in a standard 401(k) plan.
Ability to control contribution: Employers can control the contributions based on their own criteria. This works well when grouping certain employees into tenure or based on performance.
What makes me a good candidate for a cash balance plan?
Good candidates for a cash balance plan include business owners who have a large enough budget with a company relatively small in size. Additionally, having a consistent, profitable history of positive cash flow is key.
A cash balance plan is a great option for business owners who want to help their employees save for retirement. Take the time to fully review the FAQs above to better understand cash balance plans and whether or not this retirement plan model will be a good fit for your business and employees.