Understanding Cash Balance Plans
For small business owners and executives, seeing their company grow, thrive, and sustain is humbling and rewarding. Among the rewards is the opportunity to earn and secure additional retirement wealth.
If your business has benefitted from this type of positive trajectory and has the proper capacity, we recommend considering the addition of a cash balance plan to your overall employee retirement program.
Why A Cash Balance Plan?
While the typical company 401(k) is a defined contribution plan, where the retirement benefits provided depend on employee contributions and investment performance, a cash balance plan carries a defined benefit. The definition of this is based on a stated account balance, flexible by employee and dependent on a “benefit formula” that considers age, compensation, tenure, and other potential factors.
Each year, cash balance plan participant accounts are funded using two credits:
- Pay Credit (based on a percentage of the employees compensation)
- Interest Credit (fixed or variable rate based linked to an investment index)
Another major difference in cash balance plans is that the employer bears the risk of the investment aspects of the program. With a 401(k), the employee can direct their own investments. In this way, market volatility does not affect the benefit amount; it is promised to participants.
Cash balance plans are typically geared towards owners and executives of the company. It’s attractive to these higher paid, more senior employees because this type of program comes with a much higher contribution limit when compared to a 401(k), and allows them the ability to “catch up” on their retirement savings and fully maximize the benefit. These limits also increase with age; you may be eligible to defer up to $300K of taxable income depending on your age.
In addition, because cash balance plans are a defined benefit, they may be federally insured depending on the number of participants in the plan and the nature of the operating business.
And, from a distribution perspective, while many participants will take a lump sum distribution or rollover from a cash balance plan, the employer is also required to offer participants lifetime annuities; 401(k) plans do not offer this option.
One more way this benefit may also be advantageous to your company is as a form of reward; the cash balance plan is essentially a retirement-based bonus that can be offered to key personnel and top talent to incent and retain them over time.
If you’re a finance or human resources leader supporting benefit programs for your growing organization, you might consider adding a cash balance plan, transitioning from a 401(k) to a cash balance plan, or, to truly maximize contributions and tax savings for employees, offering both in combination. Highly profitable small business, and those which might be maxing out their standalone 401(k) benefit, are excellent candidates for a cash balance + 401(k) plan.
To learn more about cash balance plans, please contact Alesco Advisors.