Do your partners (or co-owners) want to defer into retirement plans more than $60,000 annually – the current limit for contributions to plans such as 401(k) and profit sharing plans? If so, a cash balance plan may be what you are looking for.
These plans allow another $250,000 annual deferral for partners in their lower 60s, and lower annual limits for younger people. In addition, a maximum accumulation of about $2.5 million per participant is possible. Recent developments, including an interest crediting rate based on the actual return on plan assets, have made cash balance plans even more attractive to plan sponsors.
Cash balance plans are defined benefit plans and therefore not subject to the $60,000 defined contribution limit noted above. Rather, these plans are subject to annual contribution requirements and other qualified defined benefit plan rules.
Plan sponsors considering a cash balance plan should first determine the level of interest among partners or primary owners. There is flexibility when setting the level of benefit for each partner, but, once determined, those levels must remain fixed to maintain status as a defined benefit plan. For example, a table of cash balance credits for partners based on compensation or ownership percentage is possible.
Minimum contributions may be required for staff, but often most of these contributions are made in the profit sharing plan in order to achieve more desirable nondiscrimination testing results.
Several plan designs should be analyzed to determine the desired level of benefits as well as the desired level of funding. The analysis should be based on tax deferral amounts, the proportion of total plan sponsor contributions that are attributed to the target group (partners or owners) and an appropriate interest crediting rate (actual return on plan assets, a published index or a fixed rate). The combination of these plan attributes can help reduce contribution volatility and ensure fairly level contribution requirements each year. Additionally, consideration of the plan design should focus on meeting required qualification requirements such as minimum accruals and nondiscrimination testing.
As noted above, a proper plan design, particularly one using a suitable interest crediting rate, should help to dampen the volatility of annual contributions. However, investment decisions should be in sync with the plan design. If maintaining a stable annual contribution is important, as well as keeping the plan fully funded on an accrued-to-date basis, the investment decisions are also critical. A traditional 60/40 equity/fixed income allocation may not be appropriate if the desired annual return is between 0% and 6%. The focus of the investment return should not only be long-term growth but also annual returns. It is important that investment decisions and investment advisors recognize this goal.
About 2,000 cash balance plans have been adopted per year in the U.S. over the last several years. Most are adopted with a 401(k) profit-sharing plan or added to complement an existing 401(k) profit-sharing plan. There are many reasons a cash balance plan may be an appropriate plan for your organization. Partnerships with a desire to accumulate retirement funds for partners while creating additional tax deductions is one obvious place where cash balance plans are attractive. Cash balance plans are also attractive to smaller companies. This is particularly true where the owner(s) spent most of their time and income growing the business and now are looking to defer some funds for retirement.
Complex rules and regulations apply to these plans. A trusted adviser can help you explore whether implementing a cash balance plan is the right decision for your company.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
