Professionals of highly profitable business are generally looking for larger tax deductions and accelerated retirement savings with minimal costs for employees, so a Cash Balance Plan working in coordination with an already established 401(k) Profit Sharing Plan may be the perfect solution for your practice. Current tax legislation is encouraging many professionals to adopt this type of plan arrangement as part of their pension programs.
A Cash Balance Plan is a “tax qualified” retirement plan, similar to a 401(k) Profit Sharing Plan in that it allows for tax deductible contributions and deferral of taxes, as well as creditor protection under Employee Retirement Income Security Act (ERISA).
While assets of a Cash Balance Plan are invested in a single pooled investment account, each participant has an account, similar to a 401(k) Profit Sharing Plan, that is record kept by the plan actuary, who generates annual participant statements, so that employees know what they have accumulated in the plan.
Participants’ account balances in a Cash Balance Plan grow annually in two ways:
1. The employer’s contribution, which is a percentage of compensation or a flat dollar amount based on a formula specified in the plan document, and;
2. An annual interest credit, which is a guaranteed rate of return, independent of the plan's investment performance. The guaranteed rate varies each year but is generally equal to the yield on 30-year Treasury bonds, which has hovered close to 5% in recent years.
Advantages of Cash Balance Defined Benefit Plans
The opportunity for larger tax deductible contributions for partners than permitted by 401(k) Profit Sharing Plans.
As an enhancement to an existing pension program, it attracts competent employees and serves to increase retention.
Contributions required for Cash Balance Defined Benefit Plans are generally less volatile from year to year and allow lower costs for employees than Traditional Defined Benefit Plans.
Tiered levels of benefits are attractive to partnerships who desire different levels of contributions for partners and employees.
Many employees seem to understand the account balance concept and appreciate the value of an account balance more than the value of the promise of an annuity payable in the future.
Cash Balance Plan assets are portable on termination of employment in that vested balances can be paid as lump sum distributions, which can be rolled over to an IRA or another qualified retirement plan. When a participant terminates employment, they are eligible to receive the vested portion of their account balance. The vesting schedule required for Cash Balance Plans is a so called 3 year “cliff” vesting schedule whereby accounts are not vested for the first two years of service, but are fully vested after 3 years of completed service.
Good Candidates for Adopting a Cash Balance Plan
Professionals who desire to contribute more than $50,000 annually to their retirement accounts.
Many professionals neglect their personal retirement savings while they are building their practice and often have a need to catch up on years of retirement savings. Adding a Cash Balance Plan allows rapidly accelerated savings with pre-tax contributions that can range from $100,000 to $220,000, depending on the demographic mix of eligible participants.
Business already contributing 3-4% of compensation to employees and willing to contribute more.
While Cash Balance plans are often established to primarily benefit key members of the practice or other highly compensated employees, the plan normally requires a minimum contribution of between 7% and 9% of compensation pay for staff in the Cash Balance plan or a separate Profit Sharing 401(k) plan.
Business Practice which have demonstrated consistent profit patterns.
Because a Cash Balance Plan is a pension plan with required annual contributions, a consistent cash flow and profit is important to its continuation.
Professionals over 40 years of age who desire to "catch up" or accelerate their pension savings.
Contributions allowed for partners and required for employees in Cash Balance plans are dependent on the demographic mix of eligible employees, and work best with the majority of eligible employees being relatively younger than owners. Therefore, older owners generally accelerate their retirement savings faster.
Other Considerations
Profit Sharing Plans on their own allow flexibility for contributions to vary from year to year depending on profitability, but Cash Balance Plans require amendment in order to accommodate the need for different levels of contributions. There is a restriction on the frequency of amendments unless a valid economic reason exists.
If profits are not expected to support its Cash Balance Plan contribution, then the plan can be amended to accommodate either a lower level of contribution or no contribution at all.
Any amendment reducing or freezing contributions must be adopted 30 days before employees complete 1,000 hours. Amendments for increases to contributions must be adopted within two and a half months following the end of a plan year.
Qualified plans’ assets are protected from creditors in the event of bankruptcy. The anti alienation provision of ERISA states that "each pension plan shall provide that benefits provided under the plan may not be assigned or alienated", which means that the assets in a qualified plan are not available to creditors. Since professionals and business owners often consider asset protection a premium, it is very advantageous to accrue retirement savings in an asset-protected vehicle, like a qualified plan. These plans provide a means for business owners and partners to move assets from their businesses to a pension plan. Once in the qualified plan, these assets are then protected from creditors as a "nest egg" for retirement or to pass on to heirs.
Cash Balance Defined Benefit Plans can enhance the effectiveness of the companies retirement program, but they must be designed thoughtfully and managed professionally using state of the art technology and processes, effective communication and education for your employees.
Consultative guidance by professionals such as enrolled actuaries, certified pension and employee benefit consultants are essential to help you get the most out of the Cash Balance Defined Benefit Plan as part of your retirement program.
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