OVERVIEW OF PLAN TYPES

An employer who decides to sponsor a retirement plan for its employees is faced with countless choices. Certain plans represent administrative ease. Other plans come with more favorable tax incentives. Still other plans provide flexibility. An employer can pick the funding arrangement, as to whether the employer or the employee or both will contribute to the retirement plan. Selecting the right plan is important, because it impacts the benefits received, the cost of operation, the employer's tax liability, perception by employees, and, ultimately, overall company profitability.

CASH BALANCE PLANS

A cash balance plan is a type of defined benefit pension plan that possesses certain characteristics of a defined contribution plan. Mandatory contributions are made to employees’ hypothetical accounts based on any number of objective factors defined in the plan document such as compensation, age, or length of service. Earnings based on the Plan Document definition are also credited to employees’ theoretical accounts. The benefit accruals and earnings are guaranteed, i.e. the employer, not the employee, bears the risk of actual investment experience

ADVANTAGES

  • This type of plan is easier for the typical employee (and employer) to understand than a traditional defined benefit pension
    plan
  • These plans carry the potentially higher deduction limits of defined benefit pension plans
  • The employer’s financial liability is more predictable than in a traditional defined benefit pension plan
  • Older higher paid employees may receive higher benefits than in a defined contribution plan
  • Participants in a cash balance plan generally choose to receive benefits in the form of a lump sum at termination or retirement, as in a defined contribution plan. This offers administrative simplicity to the plan administrator, and stable, portable benefits to the employee. Benefits may, however, be paid in the form of an annuity, which is the normal form of benefit
  • A cash balance plan lends itself to elaborate plan design. It can be combined with a defined contribution plan sponsored by the employer
  • A cash balance plan may be sponsored by a taxable entity, a tax-exempt entity, a church, or a governmental entity

POSSIBLE DISADVANTAGES

  • Since it is a defined benefit pension plan, contributions to the plan are required, and not discretionary
  • Cash balance plans are subject to certification by an actuary, and insurance oversight by the Pension Benefit Guaranty Corporation (PBGC), a government agency. This adds to the cost of plan administration

ANALYSIS

A cash balance plan can be designed to target certain groups of employees for higher benefits, as long as the plan is able to demonstrate compliance with all the nondiscrimination and minimum participation requirements of the Internal Revenue Code.

EXAMPLES(S)

– FOR ILLUSTRATION PURPOSES ONLY
  1. Cash Balance plan combined with 401(k) Defined Contribution Plan
    Age Comp. 401(k) Deferral Defined Contribution Cash Balance Credit Total
    HCE1 60 $245,000 $23,000 $13,350 $214,000 $250,350
    HCE2 52 $245,000 $23,000 $13,350 $143,500 $179,850
    Total – $490,000 $46,000 $26,700 $357,500 $430,200
    NHCE1 21 $30,000 $0 $2,250 $500 $2,750
    NHCE2 25 $40,000 $0 $3,000 $0 $3,000
    NHCE3 60 $50,000 $0 $3,750 $0 $3,750
    NHCE4 45 $60,000 $0 $4,500 $0 $4,500
    Total – $180,000 $0 $13,500 $500 $14,000
    Grand Total $670,000 $46,000 $40,200 $358,000 $444,200
  2. PBGC Cash Balance plan combined with 401(k) Defined Contribution Plan
    Age Comp. 401(k) Deferral Defined Contribution Cash Balance Credit Total
    HCE1 60 $245,000 $23,000 $31,500 $214,000 $268,500
    HCE2 52 $245,000 $23,000 $31,500 $143,500 $198,000
    Total – $490,000 $46,000 $63,000 $357,500 $466,500
    NHCE1 21 $30,000 $0 $2,250 $500 $2,750
    NHCE2 25 $40,000 $0 $3,000 $0 $3,000
    NHCE3 60 $50,000 $0 $3,750 $0 $3,750
    NHCE4 45 $60,000 $0 $4,500 $0 $4,500
    Total – $180,000 $0 $13,500 $500 $14,000
    Grand Total $670,000 $46,000 $76,500 $358,000 $480,500

CONCLUSION

An employer with a marked concentration of highly compensated employees, who wishes to provide benefits in excess of the Internal Revenue Code’s defined contribution annual addition limit ($49,000 indexed) to these employees, will find the adoption of a cash balance plan beneficial:  either in conjunction with a defined contribution plan, or on a stand-alone basis