As a business owner, exploring cash balance plans may be
beneficial to you and your employees. A cash balance plan is a retirement plan option that combines the features of a defined contribution and a defined benefit plan to provide a guaranteed income upon retirement.
While these types of retirement plans offer a range of benefits for employers, there are some disadvantages to be aware of. When deciding which plan option is right for your business, assess the following pros and cons of cash balance plans and how they can impact your business.
Pros of Cash Balance Plans
Easy to Understand
Annual contributions are calculated according to a simple, predetermined formula. Below is an example formula used to determine the annual benefit an employee receives under a cash balance plan:
Annual benefit = (wage x pay credit rate) + (account balance x interest credit rate)
Additionally, these plans allow employees to easily track their retirement funds, as the benefit is given a dollar amount.
Tax Deferred Savings
These types of plans are considered qualified plans, which means they meet the requirements of Internal Revenue Code Section 401(a). As a result, both the employer and employee receive tax benefits. Employers receive a tax break for contributions made for employees, while employees have an opportunity to defer their tax on the fund and reduce taxable income.
Higher Contribution Limits
The contribution limits for cash balance plans are higher than traditional defined contribution plans. This allows those employees who need to maximize their retirement in a short time to do so. When compared to a standard 401(k), plan participants are able to contribute and accumulate more to their retirement fund.
Cash balance plans are flexible in nature, which is highly beneficial for both employers and employees. They offer portability, as retirement funds can be transferred or rolled into an IRA if employees leave the company. Employers can also contribute to their own plans as well as control the contributions made to employees. For example, they can make contributions based on performance or tenure.
Cons of Cash Balance Plans
The employer bears all the responsibility to provide the benefits if key pieces of the plan do not work. The plans require steady and consistent payments regardless of the financial health of the company and the economic times.
Excise Tax Penalties
In some cases, the funds in plan accounts may exceed the present value of the participant’s benefits. This could result in a plan reversion, where the employer recaptures the excess funds and incurs a 50% excise tax.
The IRS has established specific regulations to ensure the contributions or benefits do not discriminate in favor of certain employees. Employers must undergo required testing every year to remain compliant.
Any changes to the plan must be amended within a certain timeframe. This means that if the plan sponsor chooses to change the formula for the benefits, it has to be made prior to the employees accruing a benefit for that specific year.
It is important for employers to weigh the pros and cons before deciding to implement a cash balance retirement plan for their employees. For most employers, it brings a lot of value that could outweigh the disadvantages, but doing your due diligence is key. Learn more about Caldwell Trust and how they can help choose the ideal retirement plan option for your business.