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Cash Balance Plans

Cash Balance Plans

| March 24, 2021
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In corporate America, pension plans may be fading away. Only 14% of Fortune 500 companies offered them to full-time employees in 2019. In contrast, legal, medical, accounting, and engineering firms are keeping the spirit of the traditional pension plan alive by adopting cash balance plans.1

Owners and partners of these highly profitable businesses sometimes get a late start on retirement. Cash balance plans give them a chance to catch up since these defined benefit plans are age-weighted: the older you are, the more that can sock away each year, up to $336,000, depending on your age.2

How does a cash balance plan differ from a traditional pension plan? In a cash balance plan, a business or professional practice maintains an account for each employee with a hypothetical “balance” of pay credits (i.e., employer contributions) plus interest credits. The plan’s objective is to pay out a pension-style monthly income stream to the participant at retirement – either a set dollar amount or a percentage of compensation. Lump-sum payouts are also a choice. Another important factor to keep in mind is that cash balance plans are commonly portable: the vested portion of the account balance can be paid out if an employee leaves before a retirement date.3

An employer takes on responsibility with a cash balance plan. The plan document states that annual contributions must be made—either in the form of a percentage of pay or a lump sum. An actuary needs to advise the employer, and help the business determine the yearly contribution needed to appropriately fund the plan. The employer effectively assumes the investment risk, not the employee.3

Cash balance plans must cover at least 50 employees or 40% of the firm’s workforce, whichever is lesser. They can be used in tandem with 401(k) plans.4

Benefits are based on career average pay.  In a traditional defined benefit plan, the eventual benefit is based on a 3- to 5-year average of peak employee compensation multiplied by years of service. In a cash balance plan, the benefit is determined using an average of all years of compensation.3

Cash balance plans can be less sensitive to interest rates than some pension plans. As rates rise and fall, liabilities in a traditional pension plan fluctuate. This may open the door to either overfunding or underfunding (and underfunding is a major risk right now with such low interest rates).

A cash balance plan cannot be administered with any degree of absentmindedness. It must pass yearly non-discrimination tests; it must be submitted for Internal Revenue Service approval every five years instead of every six. A plan document must be drawn up and periodically amended, and there are the usual annual reporting requirements.

Ideally, a cash balance plan is run by highly compensated employees (HCEs) of a firm who are within their prime earning years. In the ideal scenario for non-discrimination testing, the HCEs are 10-15 years older than half (or more) of the company’s workers.

If trouble occurs and a company flounders, cash balance plan participants have a degree of protection for their balances. Their benefits are insured up to their maximum value by the Pension Benefit Guaranty Corporation (PBGC). If a cash balance plan is terminated, plan participants can receive their balances as a lump sum or request periodic payments.3

Contact me with questions or comments. 

Todd Jakubik, CFP®

Total Financial Concepts, Inc

106 Apple Street

Suite 204

Tinton Falls, NJ 07724

Phone: 732-225-7404

Citations:

  1. Willistowerwatson.com, June 25, 2020
  2. Medicaleconimics.com, January 23, 2019
  3. Smartasset.com, December 11, 2019
  4. Investopedia.com, November 5, 2020

Disclosure:

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Compliance Note:  A1RB-0105-Jan22

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The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. Some of this material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG Suite is not affiliated with the named representative, broker - dealer, state - or SEC - registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.

Securities and Investment Advisory Services offered exclusively through Registered Representatives of Hornor, Townsend & Kent, LLC. (HTK). Registered Investment Advisor, Member FINRA/SIPC. 110 Fieldcrest Avenue, Suite 21, Edison, NJ 08837. (732) 225-0777. HTK is a wholly owned subsidiary of The Penn Mutual Life Insurance Company. Total Financial Concepts, Inc. is not affiliated with HTK. HTK does not offer tax or legal advice. It is important to consult a qualified professional for specific information regarding your personal situation. Our representatives are insurance and securities licensed in their resident state of NJ. Please contact our office for specific state registration and licensing information. This is not an offer or solicitation in any states where not properly licensed and/or registered. 2180831TM_Aug21