For your clients
For a profitable owner in their 50s or 60s, a cash balance plan is often the biggest planning opportunity there is. The assets are trustee-directed, so investment management stays central to the relationship.
Contributions above 401(k) limits
Because a cash balance plan is a form of defined benefit plan, it’s subject to actuarial limits rather than the $72,000 annual limit for 401(k) profit sharing plans (plus catch-ups for those 50 or older). The possible contribution rises with the participant’s age.
| Age | 401(k) profit sharing | Cash balance | Total |
|---|---|---|---|
| 45 | $72,000 | $159,000 | $231,000 |
| 50 | $80,000 | $204,000 | $284,000 |
| 55 | $80,000 | $262,000 | $342,000 |
| 60 | $83,250 | $336,000 | $419,250 |
| 65 | $80,000 | $349,000 | $429,000 |
Pairing with a 401(k) profit sharing plan
Cash balance plans are usually combined with a 401(k) profit sharing plan, which allows special nondiscrimination testing that keeps staff costs in check. Profit sharing contributions for employees typically average 5% to 7.5% of pay.
Only a minimum number of employees must be in the cash balance plan, for a small contribution: the lesser of 40% of eligible employees (i.e., employees with at least one year of service, age 21 or older) and owners, or 50.
Contributions are required
Cash balance contributions can be suspended or changed by plan amendment before any employee works 1,000 hours in the year, which is typically by June. After that, the year’s contribution is required unless the plan has excess investment earnings to offset it.
Investments
Investments must be directed by the trustee; participants can’t self-direct. The plan document sets an interest crediting rate, such as the 30-year Treasury rate or a fixed rate like 5%. Rates above 5.5% usually hurt nondiscrimination testing and benefit payments, and rates below 4% can raise required contributions for employees.
The trustee and their investment advisor need a prudent investment policy that aims to meet the stated rate with low volatility. Returns below the rate create an underfunding that future contributions or earnings must make up. Returns above it create a surplus that reduces future contributions.
Maximum benefits
Cash balance plans are subject to IRS maximum benefit rules for defined benefit plans. For participants in their sixties with 10 years of participation, the maximum lump sum is about $3.8 million. Accounts need careful monitoring, because amounts above the maximum can’t be paid out and can be subject to excise taxes.
Plan expenses
The employer decides how plan expenses are allocated. Partnerships should review their partnership agreement to make sure cash balance contributions are funded according to the plan document rather than the partnership’s usual expense provisions.
Benefit payments
As with a 401(k), a payment from a cash balance plan can be rolled over to an IRA to defer taxes. The plan must offer an annuity to terminated participants with balances over $7,000, but it can also allow lump sums at termination of employment, death and disability, and in-service withdrawals at age 59½. The plan sponsor can terminate the plan and pay out all benefits at its discretion.
PBGC premiums
Cash balance plans are insured by the Pension Benefit Guaranty Corporation unless the sponsor is a professional service firm with 25 or fewer participants. Covered plans pay annual premiums based on the number of participants and any underfunding.