Cash Balance Plans
A cash balance plan (often referred to as a hybrid plan) is a defined benefit retirement vehicle that resembles a defined contribution plan because the employee’s benefit is expressed as a hypothetical account balance instead of a monthly benefit payable at retirement age. Although cash balance plans have been around for over 30 years, there has been a recent resurgence in their popularity and adoption. This has been due to many factors, including the enactment of the Pension Protection Act (PPA) of 2006 and that this type of plan can provide tax-deductible benefits as much as five times greater than a 401(k) profit sharing plan. Professional practices, in particular, have been very receptive to these plans, often establishing them in conjunction with 401(k) profit sharing plans.
In a cash balance plan, the employer guarantees a contribution level and minimum rate of return. Each employee’s “account” receives an annual contribution credit, which is usually a percentage of compensation, but may be a flat dollar amount, and an interest credit based on a guaranteed rate (typically 5%) or some recognized index such as the 30-year Treasury rate. The funding of these annual allocations is determined by an actuary; however, subject to discrimination laws, you can be very flexible with the plan design, specifically the weighting of plan benefits toward an owner(s) or any other designated employees within the organization.
At retirement, the employee’s benefit is equal to the hypothetical account balance, which represents the sum of all account allocations and interest credits. Although the plan is required to offer the employee the option of using the account balance to purchase an annuity benefit, employees generally will take the account balance and roll it over into an individual retirement account (unlike many traditional defined benefit plans which do not offer lump sum payments at retirement).
As in a traditional defined benefit plan, the employer in a cash balance plan bears the investment risks and rewards. An actuary determines the annual contribution to be made to the plan, which is typically the sum of the contribution credits for all employees plus the amortization of the difference between the total value of the account balances and the value of the plan assets reflecting actual investment earnings (or losses).
As the plan progresses over the years, the available contribution range that is actuarially determined often may be broader than actual account allocation for the year, providing even more contribution/deduction options for the plan sponsor.
Employees appreciate this design because they can see their “accounts” grow but are still protected against fluctuations in the market. In addition, a cash balance plan is more portable than a traditional defined benefit plan since most plans permit employees to take their account balance and roll it into an individual retirement account, or other qualified retirement plan, when they terminate employment or retire.
To learn more about cash balance plans, follow the links below or call our office to speak with a cash balance expert to find out if this type of plan is right for you.