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Take another look at cash balance plans

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Another look at cash balance plansCompensation and Benefits Bulletin
Your firm’s partners or owners may need to accumulate funds for retirement, perhaps beyond the 401(k)/profit-sharing annual contribution limit. Cash balance plans can be designed to significantly accumulate retirement benefits for owners/partners. In many cases, annual contributions for older individuals can exceed $200,000, in addition to maximum contributions by an individual and company in a 401(k)/profit-sharing plan of $53,000 ($59,000 for participants at least age 50). Benefit levels can also vary by individual and be weighted in favor of partners/owners.

Your company may need a reasonably priced benefit program for all employees to separate it from competitors’ programs. Cash balance plans can be designed as a benefit for all employees. An example would be a plan that credits 3% of annual compensation to each individual’s account yearly and credits 4% annual interest. Because the plan is a defined benefit plan, required contributions are calculated actuarially, but, depending on demographic experience and asset returns, the long-term costs could be in the range of 3% to 5% of payroll.

Cash balance plans have become the predominant defined benefit plan. The benefits are relatively easy for the plan participant to understand because accrued benefits are defined in terms of an account balance, similar to a savings or profit-sharing account. In addition, the lump sum payable upon a participant’s termination is simply the nominal account value, which is not related to current interest rates.  

The plan’s benefit formula is defined in the form of a nominal account to which employer contributions and interest are added. (There are actually no individual asset accounts.) At retirement, the participant may elect to take a lump sum distribution even though a joint and survivor annuity is required to be the default form of payment (that is, an annuity paid out over the lifetime of the individual and his or her spouse).

Minimum contributions, annual actuarial valuations, filings and notices are requirements, as for any qualified defined benefit plan. Specific plan design features and prudent asset management can significantly lessen contribution volatility. Employer contributions are tax deductible, and participants are taxed when they receive benefits, as with any qualified plan.

Today’s most popular cash balance plan design uses general nondiscrimination testing to combine the benefits payable under a cash balance plan with a 401(k)/profit-sharing plan. This plan design allows maximum weighting of benefits to designated individuals, which has caused many professional partnerships and privately held companies to choose this plan design.  

Contributing to the recent popularity are recent regulations that have clarified some outstanding issues and made an interest crediting rate equal to the actual return on assets an attractive option. These cash balance plans are referred to by several names including “actual rate of return plans” and “market-based cash balance plans.” Benefits can increase or decrease within limits based on the actual return of plan assets. This design significantly lessens the investment risk to the employer and also the volatility of contribution requirements.

Whether your firm is a partnership, a small owner-dominated company or a large company, a cash balance plan may be the benefit program that best suits your needs.

Contact
Ray Berry
+1 312 602 8333
ray.berry@us.gt.com

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