The right retirement plan is an essential part of your business. For some businesses, a cash balance plan makes the most sense. This hybrid pension plan combines 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 charges - into a hypothetical retirement account, allowing them to track their account balance. If you are exploring retirement plans for your business, a cash balance plan is an ideal option to consider.
A Closer Look at How Cash Balance Plans Work
What sets a cash balance plan apart from other types of retirement plans is the way in which the plans are funded. With a cash balance plan, an employer contributes a percentage of the employee's wage or a flat dollar amount using a predetermined formula into the fund each year. In addition, an annual interest credit is applied to the account each year. This amount can change based on factors like targeted earnings, calculated benefits and investment performance. This structure is similar to defined contribution plans, but cash balance plans do not rely on contributions from employees.
Cash balance plans are similar to defined benefit plans in how they are paid out. If the employee stays with the company through retirement, the funds can be delivered through annuity payments or a lump sum payment. If the employee changes jobs, cash balance plans are unique in that they allow the employee to withdraw funds before retirement or transition them into an IRA. This portability makes these plans appealing to new hires.
4 Key Benefits of a Cash Balance Plan
While you have to weigh your options when choosing a retirement plan for your employees, cash balance plans have four key benefits.
- First, they are easy to understand. Because the benefit is given a dollar amount, employees can easily track their retirement funds. Also, they are becoming increasingly popular, allowing employers to use them as an incentive to draw in more skilled talent.
- Second, cash balance plans offer tax-deferred savings. Because they are considered qualified plans, both you and your employees will receive tax benefits. Your contributions are tax-deductible expenses, and plan participants can defer their tax on the fund to help their retirement funds grow even more.
- Third, cash balance plans have higher contribution limits than defined contribution plans. For employees that need to maximize their retirement savings in a short amount of time, this is highly beneficial.
- Finally, cash balance plans are exceptionally flexible. Not only can they be transferred or rolled into an IRA if the employee leaves your company, but they also allow an owner to contribute to their own retirement plans. The employer also has the ability to control contributions, varying contributions for different groups to reward higher performing or tenured employees if desired.