Using Cash Balance Plans to Bolster Retirement Security
By: Chip Hunt, Principal and Co-Founder, PrimeTRUST Advisors
Over the past year, employees’ 401(k) and profit sharing plan account balances have declined to the point that many, who were at the very threshold of retirement, are now questioning their capability to realize that dream.
Cash balance plans may provide the solution; especially when used as a supplemental plan to serve as an organization’s retirement program underpinning to prop-up the commonly used 401(k) and profit sharing structure.
From an employee’s “retirement security” perspective, these plans possess some key advantages over typical 401(k) and profit sharing plans in several respects:
The requirement for mandatory employer contributions to fund participants’ retirement accounts,
Account balances are always credited with positive investment earnings,
Higher contribution levels may be targeted towards older workers (helps with revitalizing depreciated 401(k) and profit sharing account balances),
Expands the contribution limits otherwise imposed upon the 401(k) profit sharing plan structure; allowing the opportunity to increase the amount of contributions for some employees.
Enhanced Retirement Savings Opportunity
Traditional 401(k) and profit sharing plan structures are designed to facilitate accelerated “catch-up” contributions for older workers.
For example, in 2009, an employee’s maximum annual 401(k) contribution (salary deferral amount) is $16,500; if the employee is age 50 or older, they may contribute an additional “catch-up” contribution amount of $5,500.
When used in combination with a profit sharing plan, participants may receive an additional $32,500 for a combined total contribution of $49,0001 ($54,500 for employees over age 50).
Cash balance plan rules allow businesses to make tax deductable contributions that are in addition to the maximum dollar limit amounts for 401(k) profit sharing plans. The table to the right shows the maximum allowable contribution credits that can be made to a cash balance plan. As you can see, contributions under these arrangements allow for the flexibility to provide for a serious level of “catch-up” contributions that can assist in repairing participant account balances. It is probably obvious to most readers that these limits are well in excess of the practical limits that most businesses will ever need; therefore, the availability and advantages of such high benefit levels may be viewed as of little or no practical value. However, in certain circumstances, these plans may be “just what the doctor ordered” !
Professional service organizations (law firms, medical practices, engineering firms, architectural firms, etc.) often use the 401(k) profit sharing plan structure to fund their retirement programs. As such, their funding amounts are often severely restricted because of the $49,000/$54,500 dollar limits when the business entity actually could afford to fund more. Quite often plan sponsors turn to a “non-qualified” plan structure to fund “excess” benefits over the dollar limits. Properly designed cash balance plans may allow plan sponsors to accomplish much of this in a tax qualified plan setting; affording covered employees greater protections than a “non-qualified plan”.
Cash Balance Plans and Its Poor Image
Upon the mere mentioning of cash balance plans, some people often quickly dismiss the concept because of the negative sentiments associated these plans in the past. This is usually attributed to either of two reasons:
However, an astute analysis of the situation today, reveals quite a different truth. As such, these plans should be re-evaluated and considered as a sophisticated planning tool for savvy employers. In fact, signs of trends embracing this benefit planning concept are emerging.
Cash Balance Plans Controversy Resolved
The Pension Protection Act of 2006 finally resolved the controversy surrounding lingering age discrimination claims. Cash balance plans are now protected against challenges under the rules found in the Internal Revenue Code, the Employee Retirement Income Security Act of 1974 (ERISA) and the Age Discrimination in Employment Act (ADEA) as long as the plan meets certain specified standards affecting vesting schedules and interest crediting rates.
A Cash Balance Plan is a Defined Benefit Pension Plan
Cash balance plans too often get dismissed because they are deemed “defined benefit pension plans”; and in today’s environment… the idea of starting a new defined benefit pension plan… well… that is almost taboo.
Traditional defined benefit pension plans have received a good deal of bad press in recent years due primarily to the unpredictability and the volatility associated with required plan contributions and a plan’s funded status.
Yet, do not make the mistake of just taking a cursory look at a cash balance plan and concluding that just because it is a defined benefit pension plan, that its features resemble the troublesome traits of a pension plan. A deeper examination of a cash balance plan structure reveals something more… and that is… its plan liabilities, its funded status and its level of required contributions are much more predictable than in a traditional defined benefit pension plan.
When properly implemented with appropriate investment and funding strategies, cash balance plans virtually eliminate all of the volatility associated with plan liabilities, funded status and required contributions.
Time to Re-assess the Situation
Your current retirement program may not be taking full advantage of the most recent rules and regulations applicable to hybrid plan designs (specific to cash balance plans used in combination with 401(k) profit sharing plans).
Now may be the time to review the tax and funding efficiency of your existing retirement programs to ensure that, as a plan sponsor, you are getting the most out of your retirement benefits program.
Finally, now is the time to examine more innovative benefit strategies to help repair those depreciated participant account balances.
For more information, please visit: www.PrimeTRUSTAdvisors.com
1 The maximum allowable annual contribution limit from all contribution sources within a defined contribution setting for an individual participant is the lesser of: $49,000 or 100% of compensation. Participant catch-up contributions of up to $5,500 are allowed in addition to this amount for participants age 50 or older.