Cash Balance Plan Example Calculation: The Simple Process

chart with finance, tax and debt

You’ve probably heard by now that cash balance plans are complex. The calculation itself can be very challenging, even for a CPA like me.

In fact, if you want something straightforward, you can stick with a 401(k) or another defined contribution plan. With those plans, you have a maximum annual amount you can contribute, and it doesn’t matter whether or not your assets go up or down.

However, a cash balance plan is a little bit more involved. The complexity is a trade-off for the large plan contributions.

The goal of this post is to provide:

  • a straightforward and basic plan calculation;
  • an illustration of an initial targeted amount;
  • an application of the plan formula to calculate a contribution range; and
  • an examination of the impact of investment returns on plan funding.

But please realize that I am not an actuary. My goal is to give you some general guidance as to how contributions are calculated.

I am simplifying the calculation for illustrative purposes. But an actuary can give you a more detailed explanation of the calculation.

So make sure if you have specific questions you reach out to your administrator. Let’s get started.

Some Basics

First, some basics. A cash balance plan is in the defined benefit plan family. As such, the goal is to calculate a contribution that will provide a benefit for a plan participant at retirement.

You may be aware that cash balance plans provide funding ranges. When the actuary provides funding levels for a given year, you will receive the following:

  • Target amount
  • Minimum amount
  • Maximum amount

The target amount is the amount you should contribute to “true-up” or make the accrued benefit at a point in time the exact amount that is actuarily required.

But most people will not contribute the target amount. Fortunately, the IRS allows for a minimum contribution and a maximum contribution. While the targeted amount is the recommended amount, in reality, you can fund anything within the range and still be compliant.

The plan document will also specify the following:

  • Pay credit (flat dollar or percent of salary)
  • Interest crediting rate

In most situations, the pay credit will be a percentage of salary. The interest credit rate (or “ICR”) is usually a fixed rate of 5% (or something close).

So, now that you have some basic information, how is the annual funding range calculated? That’s what I will walk through in a very basic example and show you how this contribution would work.

Plan Assumption Example: Target Funding

So, let’s look at the first step: calculating the target. First, assume that a business owner has an S-Corp and is the only employee. The table below summarizes the plan requirements and amounts:

Owner Age56
W2 Compensation$100,000
Pay Credit100% of Compensation (in this case $100,000)
Interest Crediting Rate5%

You can use a beginning of year or end of year valuation. We typically use an end of year valuation and that will be used in this example. As such, for valuation purposes, the pay credit occurs on December 31st, so no interest credit occurs in year one (except when using prior service with an initial opening balance).

We will assume that the company opens up the plan on January 1st of the first year and contributes the amount of $100,000 on December 31st of that year. This is the target calculation based on the plan formula as illustrated above.

At the end of the year (December 31st), the owner/employee would have a hypothetical account balance of $100,000. As such, the year end account balance will equal the year one pay credit. See the table below:

Year One Pay Credit$100,000
Year End Account Balance$100,000

You can have a fixed contribution amount in year one. In fact, you could even have a fixed contribution amount throughout the life of the plan (subject to testing). But for simplicity, we have used the above amounts.

Hybrid plan

It is important to note that a cash balance plan is a “hybrid” plan. The hypothetical account balance is the amount the owner is entitled to if he or she left the company (vesting aside).

But remember, there is a disconnect between the investment account and the hypothetical account balance. That’s because it is virtually impossible for an investment return to exactly match 5%.

Let’s assume that the owner invested the entire account balance in stocks. This 100% equity allocation is not recommended and is not something any client should do. The goal is generally to mimic the interest crediting rate of 5%.

But as the client is the plan’s trustee, they can certainly use this asset allocation if they want. However, it can result in significant plan volatility.

Investment volatility

Remember that the year one contribution of $100,000 is assumed to be made on December 31st. Let’s now assume the entire account balance went down by 30% during year two. So, if the owner puts all $100,000 into stocks, the balance at the end of the year is $70,000. Take a look at the table below for year two:

Hypothetical Account Balance$100,000
Investment Account Balance($70,000)
Shortfall (or Underfunding) $30,000

This excludes the year two contribution because that is assumed to be made on December 31st, with no investment return. There is a shortage in the account of $30,000. What happens to this, and how does this affect future contributions? I’ll explain.

With an underfunded amount, we’re going to roll the calculation into the year two contribution. Do you have to make up that entire shortfall in year two, or do you have additional time?

Year Two Calculation Example

Now let’s calculate year two’s target, minimum, and maximum amount.

Let’s assume the same information in year two as in year one. The owner has the same W-2 of $100,000, which results in a 100% pay credit of $100,000.

The only difference is that the actuary now has to consider the ending year two investment balance of $70,000 and the $30,000 shortfall.

Calculating the target

In year two, the target contribution will be the amount needed to essentially “true-up” the plan. The goal is to make the target contribution the amount to get the plan asset balance to match the employee’s hypothetical amount.

Here is the year two target contribution:

Year Two Pay Credit $100,000
Year Two Interest Credit $5,000
Shortfall $30,000
Year Two Target $135,000

The target for year two would be the $100,000, plus the shortfall of $30,000, plus the year two interest credit of $5,000. So, the target is $135,000.

Calculating the minimum

Now we need to calculate the minimum. When it comes to the minimum, the IRS allows that $30,000 shortfall to be amortized over 15 years. When you amortize this over 15 years, you get $2,000.

The minimum calculation becomes the $100,000 pay credit noted above, plus the year two interest credit of $5,000 (remember there is no interest credit in year one), plus the $2,000. So the minimum is $107,000. See the table below:

Year Two Pay Credit$100,000
Interest Credit $5,000
Amortized Shortfall $2,000
Year Two Minimum $107,000

Calculating the maximum

Now it’s time to calculate the maximum contribution. This is a little bit more challenging.

When calculating a maximum, you get more flexibility to the upside. The IRS allows you to contribute up to 150% of the accrued benefit plus the current year accrual.

This is calculated by taking the ending year two balance. The employee is guaranteed a hypothetical balance of $205,000. This would be $100,000 for each of the two years, plus an interest credit of $5,000 in year two.

Then we take that amount and add an add’l 50%. This upside cushion is another $102,500. So the most you can fund would be $307,500.

We then compare this to the balance in the account from the end of the year of $70,000, and you have a maximum contribution that is the difference between those two numbers. This is calculated at $237,500. See the table below:

Maximum Allowable Funding$307,500
Balance as of End of the Year $70,000
Maximum Contribution$237,500

Final Thoughts

So the final min, max and target calculations are as follows:

Minimum Contribution$107,000
Target Contribution$135,000
Maximum Contribution$237,500

As you can see, there is a pretty wide funding range. Assuming you fund towards the target each year this range should get wider as the plan matures.

Retirement Plan Restatements: Everything You Need to Know

If you’re a business owner with an active retirement plan, whether it be a defined benefit/cash balance plan or 401(K), it’s important to be aware of required plan restatements. You can voluntarily restate your plan at any time if you want to make changes. However, there are times when restatements are required by the IRS.

What is a plan restatement and when are they required?

Retirement plans must follow a set of rules and regulations set forth by the IRS, and when these change, the plan documents must be amended based on those changes. The IRS requires pre-approved, company-sponsored plans to be restated approximately every 6 years. The Pension Protection Act (PPA), which was passed by Congress in 2006, set forth these rules. We are currently in Cycle 3, also known as Post PPA.

During the restatement process, TPA’s such as Emparion will update the plan documents and have the trustees resign these documents. These document updates might also include any amendments or changes that have been made since the original plan documents were created.

What is Cycle 3?

Cycle 3 is the name for the current restatement period for defined contribution (DC) plans. It’s named Cycle 3 because it is the third restatement that has been required by the IRS since the 6-year cycle period begun. The Cycle 1 deadline for DC plans was 04/30/2010 and the Cycle 2 deadline was 04/30/2016.

Is the Cycle 3 restatement mandatory? When is the deadline?

IRS restatements are mandatory for any pre-approved documents and must be completed by a specific deadline. The current Cycle 3 Plan Restatement deadline is July 31, 2022.

What happens if my plan documents aren’t restated by the deadline?

If your plan documents are not restated by the deadline, your plan may fall out of compliance. This could potentially lead to IRS-imposed penalties, such as paying taxes on your investment account balance.

What is a pre-approved plan? Do I have one?

A pre-approved plan is a document that has already been reviewed and accepted by the IRS. If your plan is pre-approved, you should have been issued an IRS letter along with your plan documents when your plan was first established. All plans set up by Emparion are pre-approved.

What is the cost of a plan restatement?

We charge a small fee based on plan specifics. We will let you know the price of your restatement beforehand.

What documents are included in the restatement?

The following documents will be restated:

  • Adoption Agreement
  • Basic Plan Document
  • Summary Plan Description
  • Plan Highlights
  • Updated IRS Pre-Approval Letter

What do I need to do?

Emparion will handle the restatement process. We will provide you with the amended documents electronically as well as a link to e-sign. All you will need to do is review and sign to implement the new documents.

I’m planning on terminating my plan. Do I still need to have it restated?

Prior to terminating, your plan must be consistent with the current IRS regulations. Any amendments will need to be made before your plan can be terminated. Therefore, you will still need to restate your plan unless your plan is currently up-to-date and will be terminated before the restatement deadline.

Defined Benefit Cash Balance Plan: The #1 Structure

We often talk to clients who are searching for retirement structuring. But more often than not, they are interested first in reducing their tax liability. The first option we usually select is a defined benefit cash balance plan.

Retirement advice can be challenging because all clients have unique tax and financial situations.

Retirement planning is not a one size fits all approach. If a doctor is simply an independent contractor or has just a few employees, then there are a couple of perfect structures. It will usually employ a 401k (with profit sharing) in addition to a defined benefit plan.

The majority of our doctor clients will quickly understand how 401k plans work. But a defined benefit plan is a different animal. Let’s take a look at how they work.

Retirement Advice

Defined benefit plans (as well as other types of hybrid defined benefit plans like cash balance plans) are beginning to receive increased attention. Available literature indicates that transition appears to be largely aimed at making employers more attractive to workers who do not plan to remain with the same employer for their entire career.

A defined benefit cash balance plan promises these workers a larger benefit than they would receive under a traditional defined benefit pension plan, as well as a benefit accrual pattern that may be better understood.

Cash balance and other hybrid plans contain features of both defined benefit (DB) and defined contribution (DC) plans. This allows the plan sponsor and participants to take advantage of features of both types of plans (see our dummies post).

Retirement Advice for physicians

One key reason for the growth of cash balance plans was the improved ease of understanding of a participant’s retirement benefit. Another reason was the movement to retirement income based on lump sum values, similar to 401(k) savings plans, and the availability of lump sum payment options.

More recently, small employers have adopted cash balance plans since defined benefit plans may provide higher retirement income than defined contribution plans. A cash balance pension plan is a defined benefit pension plan. Cash balance plans are career average plans in which benefits are accrued incrementally year by year.

Defined Benefit Cash Balance Plan Formula

The benefit is defined by a formula containing a specified pay credit (or allocation) which is placed into a hypothetical account for each participant. A cash balance plan mimics a money purchase pension plan formula; the employer contributes to each participant a percentage of their plan year compensation (as opposed to average annual compensation).  

This allocation is called a “Hypothetical Allocation”. To determine a participant’s accrued benefit at any particular time, the hypothetical account balance is projected, with interest, to normal retirement age. This projected lump sum amount is then converted to an annuity by dividing the amount by the an annuity purchase rate specified under the plan.

Let’s examine some of the advantages of a defined benefit plan:

  • In general, they allow for significantly higher employer contributions than other types of plans. This allows you to take a large tax deduction and funnel substantial funds into the plan. We can assist in the calculation.
  • Significant benefits possible in a relatively short period of time.
  • Can be combined with other retirement plans including a 401k.
  • Can be a business of any size in any industry including solo practitioners.
  • Vesting can be immediate or spread out over a seven-year period.
  • Plan can be used to promote certain business strategies by offering subsidized early retirement benefits.
  • Participant loans are allowed.
  • No set contribution limits. The deduction limit is calculated by an actuary and is any amount up to the plan’s unfunded current liability.
  • Benefits are not dependent on asset returns.

Quality retirement advice for doctors should encompass many factors. But the most important is considering a defined benefit plan. This is often the best strategy of all.

Are you looking to stash more money into retirement? A pension plan may be a great option for you. I will show you how setting up a pension plan might not be as tough as you might think.

While a majority of the business world has moved to defined contribution plans, such as 401Ks, the pension plan or defined benefit plan has many benefits that you may want to consider.

Plan Strategies

How do you set up a pension plan? It’s not as hard as it seems. Check out our simple how-to guide below.

There are a lot of requirements that go along with setting up a pension plan. Let a seasoned financial advisor help you navigate the rules and regulations. The advisor needs information about your employees, their ages, and salaries to calculate the amount you must contribute to the plan based on your chosen percentage and the IRS rules.

Financial planning puzzle piece

Your pension plan document is the governing document that includes all the rules and regulations of the plan. This includes details such as the amount of the contributions (percentages) and interest rates. The plan document must follow all IRS rules but can incorporate its own rules and regulations as well, as long as they are within the law.

Illustrate what the plan looks like to you as this helps keep you accountable. Make sure you have provisions in place should your company face issues and be unable to make contributions.

Your plan or illustration should include plans to amend and freeze the plan, if necessary. It should also include the options and circumstances under which you can terminate the plan and how you’d distribute the assets to participants.

Choose a Third-Party Administrator

Rather than taking on the administrative components of a pension plan, hire a third-party administrator to handle it for you. TPAs work alongside you to help you remain compliant and accurate in your record-keeping and plan contributions/distributions.

A TPA can help you create the plan documents, prepare statements, perform annual reviews, prepare necessary reports for the IRS, calculate contributions, and manage audits.

Make the required contributions

You must make all necessary contributions by the due date of your tax returns, whether you are on a calendar year filing or tax year filing. If you need an extension, aka can’t make your contributions on time, you may request an extension of 8 ½ months. If you’re on the calendar year plan, this means your contributions for the previous year would be due by September 15th.

Plan Structuring

It’s not as difficult as it seems to set up a pension or defined contribution plan and there are many benefits of doing so. If you are looking for ways to entice more talented people to work for your company or you need a tax-friendly way to catch up on your own retirement plans, the pension plan is a great idea.

The key is to have proper help. Don’t try to manage this process alone. While you try to manage and grow your business, you need qualified personnel to help you run your pension plan as there are many laws and regulations you must follow.

If you do, though, you benefit from the tax advantages, the ability to increase your own retirement savings at much higher levels, and the possibility of attracting and keeping great employees.

In summary, setting up a pension plan for your business requires the help of:

  • A financial advisor – This person will help you make decisions right upfront. You’ll choose the right plan, see the pros and cons of other plans, and make contribution decisions. You’ll go over the IRS rules and regulations and decide what steps you should take, including the type of vesting you’ll offer, whether cliff or gradual.
  • third-party administrator – Once you have the plan in place, don’t let the administrative tasks take over your day. Again, focus on your business and growing it as that’s the only way you’ll keep up with your required contributions. Find a TPA that you work well with as you’ll be in constant contact throughout the year.

Setting up a Defined Benefit Cash Balance Plan

Once you have the proper help in place, the rest of the steps are easy for you to manage:

  • Create your documents – You want your documents to be as straightforward and informative as possible. You want your employees to understand the plan and see it as an advantage of working with you. Of course, always have an open door with your employees, allowing them to ask questions of you or the TPA to determine where they stand with their retirement accounts.
  • Be flexible – If things happen down the road (as we all know life is unpredictable), you need plans in place to freeze or terminate your plan. Don’t let your plan become a liability; instead, have plans in place with the help of your support system that allows changes to the plans that will allow your business to stay afloat while keeping you in line with the IRS rules and regulations.

Bottom Line

If you’re interested in setting up a pension plan, start today! The sooner you start the more money you’ll accumulate for yourself and your employees. Setting up a pension plan can be straightforward with the right help and following the IRS guidelines. Get yourself and your employees set up for retirement today.

Cash Balance Retirement Plan: Our Favorite Structure [+ IRS Hazards]

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Even though recent tax reform has lowered tax rates, chances are you still are looking for a few tax breaks. Have you ever considered a cash balance retirement plan?

No one really likes to pay taxes and most of us will try to find a way to legally avoid taxes the best we can. Fortunately for you, I am here to tell you about a little-known strategy to massively reduce your annual taxes.

The cash balance plan is your safest bet to create a retirement pension plan for yourself in the most tax-efficient manner possible.

Cash balance plans are certainly more complex compared to basic 401k plans. But don’t be intimidated. Once you know the basics, you might find that they will work great in your situation.

What is a cash balance retirement plan?

A cash balance plan is a fresh twist on a traditional defined benefit/pension plan.

Like in a traditional DB plan, the participant in the cash balance plan is also told that he or she will receive a certain guaranteed amount on retirement. The participant can choose to take out the amount in lump sum or commit to an annuity that pays a portion of the guaranteed amount in regular checks, upon retirement. The contributions made to the plan are completely tax-deductible, which means that every dollar saved is a dollar not taxed.

However, the feature that differentiates it from a traditional pension plan is that it also works like a 401k plan (defined contribution fund), where each participant has his/her own individual account, in which the employers make monthly contributions.

Financial planning puzzle piece

The participants are sent an individual statement which shows the hypothetical account balance or the benefits that the participant has earned over time. Due to the cash balance plan sharing common features of both defined benefit funds and defined contribution funds, they are sometimes referred to as “hybrid plans”.

How does it work?

For each year, the employee works for his company, the benefits into his cash balance plan will accrue using the following formula:

Annual benefit = (Wage x salary credit rate) + (account balance x interest credit rate)

Let me explain this formula with the help of an example. John earns $100,000 in salary annually. The ongoing salary credit rate in the company he works for is 5%, which represents the percentage of the employee’s wage that the employer must contribute annually in the plan. This means that the employer must contribute $5,000 as “compensation credit” to John’s plans each year. This is the first component of the annual benefit to be accrued to John.

The second component is the amount the employer must contribute for the “interest credit” or growth of the cash balance plan, which can be found out by multiplying the year beginning account balance with the interest credit/growth rate.  The interest rate could be fixed or variable as it is tied to an instrument, like the interest on a 30-year Treasury bond.

If the account has an opening balance of $400,000 and the interest credit rate is 6%, this will mean that the employer must contribute another $24,000 for John’s plan. The total annual benefit will amount to $29,000 as given by the calculations below:

Annual benefit = (Wage x salary credit rate) + (account balance x interest credit rate)

Annual benefit = ($100,000 x 5%) + ($400,000 x 6%)

Annual benefit = ($5,000) + ($24,000)

Annual benefit = $29,000

Benefit to Small Business Owners

If you are a small business owner, the cash balance plan will give you the option of contributing more to your retirement plan than the traditional 401k or Roth IRA account, as shown in the table below.

Many people also use the cash balance plan in conjunction with their 401k plans to maximize their annual contribution limits and hence their tax savings. Usually, successful business owners are in their early 40s and are making a consistent income of $200,000 or more, annually.

They have only recently started making this amount of money and now they want to save it up. Till this point in their lives, they haven’t been able to save much due to heavy capital investments in their businesses and other expenses due to which their retirement funds are almost non-existent.

The cash balance plan is an ideal solution for them to turbocharge their retirement savings plan. As you can see from the table above, cash balance plans are age-dependent and older participants can contribute more annually to this tax haven and boost up their retirement plans significantly.

With a cash balance retirement plan, each owner will have an individual account. This makes it easier to allocate a different amount to each owner since they might have different retirement ages. The owner can also make his spouse as a partner in the business which could potentially double the amount of contributions that can be made in the plan.

Cash Balance Retirement Plan Rules

The hypothetical cash balance pension accounts are a bookkeeping device to keep track of participants’ accrued benefits and are not directly related to assets in the plan. A cash balance plan is considered a specific type of defined benefit plan because accrued benefits are not determined solely by the value of investments.

Because it is a defined benefit plan, employer contributions are calculated using actuarial assumptions and funding methods. The trust asset value will usually differ from the sum of the participants’ accounts.

Spouse consent is also necessary for any non-joint and survivor form of benefit. Joint and survivor percentages must be 50% larger. Pension payment cannot be split between spouses, except when a court orders so due separation or divorce.

Contributions are formula-driven. The formula is spelled out in the plan document. It is usually a percentage of compensation or a flat dollar amount. In practice, the amounts below will vary depending on the annual salary.

How to structure a plan

As a qualified pension plan, employers offer a cash balance plan to eligible company employees as a retirement structure. The employer must contribute a percentage of employee compensation and an interest credit.

Suppose an existing defined benefit plan amendment converts a cash balance defined benefit plan. In that case, the participant’s account balance is the sum of the former accrued benefit plus any benefit earned from post-conversion service under the cash balance formula. Conversions must preserve the accrued benefit with all future services creating cash balance account additions.

Are employee contributions to a cash balance retirement plan allowed? No, they do not. Cash balance plans do not allow employee deferrals. The company solely makes contributions. The company must ensure adequate funds to contribute to all qualifying employees. If employees are looking for an additional way to contribute, they will need to do an employee deferral on a 401k plan.

Final Thoughts

Due to the flexibility of cash balance plans and the fact that they are one of the best tax havens out there, they have increased tremendously in popularity in recent times.

Selling Your Business: What Do You Do With Your Cash Balance Plan?

Let’s assume that you have a cash balance plan or another defined benefit plan, and you decide to sell your business. What happens next? Does the plan carry on to the new owner, or can you transfer it to a new company you own?

The answer depends on how the business sale is structured and your intensions. This post will discuss how business sales are structured and how these structures impact your retirement plan. Let’s get started!


There are two primary business sale structures:

  1. Asset purchase; or
  2. Stock purchase

There are pros and cons to the above structures. In general, the buyer wants to do an asset purchase, and the seller wants to do a stock sale. These diverging positions can make the negotiation process complex.

While there are many issues when negotiating these deals, it usually comes down to tax implications, current contractual relationships, liability exposure, and the strength of the brand of the existing business.

Asset Sale 

With an asset sale, the buyer is merely acquiring the company’s assets (and possibly the liabilities). They are not buying the company (stock or membership interests). So, in essence, the old company is dissolved or carries on in a limited capacity.

The buyer will usually set up a new company to hold the assets. If the buyer is already in business, they will typically merge the newly acquired assets into their existing business.

In an asset sale, the seller maintains the legal entity. The buyer simply acquires the individual assets, such as computers, fixtures, equipment, licenses, and inventory.

But most importantly, they acquire the goodwill and customer lists. In most service businesses, the value is in intangible items like goodwill and customer lists. 

The significant advantage for the buyer is that with the asset purchase, the assets get a “step-up” in basis. The purchase price is then allocated to the purchased assets.

Equipment, computers, and other tangible assets are depreciated over their useful life, typically 3-7 years. The remaining purchase pricing is usually allocated to goodwill and other intangible assets with a 15-year useful life. As such, the depreciation expense for these items is a great benefit to the buyer. 

In addition to the tax benefits, buyers like asset purchases because they more easily avoid potential liabilities, especially contingent liabilities relating to employees, product liabilities, contractual disputes, and other legal exposures.

However, asset purchases can present problems for buyers. Due to assignability, legal ownership, and third-party consent, contracts can be challenging to transfer. Obtaining consent and transferring contracts can slow the transaction process.

For sellers, asset sales can generate higher taxes. Intangible assets, such as goodwill will be taxed at capital gains rates. However, other tangible or “hard” assets are often subject to higher ordinary income tax rates.

If the selling entity is a C-corporation, the seller faces double taxation. It is taxed upon the initial sale and then again when dividends are transferred to the shareholders.  

Stock Sale

With a stock purchase, the buyer acquired the selling shareholders’ stock or membership interests (for an LLC) directly through a sale. As such, the seller just steps in place of the seller, and the business and legal entity will carry on. Unlike an asset purchase, stock sales do not require numerous separate conveyances of each asset because the title lies within the corporate entity.

Because the buyer is taking the seller’s place, there is no step-up in basis. The seller will pay capital gains on the difference between the sale price and the seller’s basis in the assets.  

The stock purchase agreement can mitigate these liabilities through representations, warranties, and indemnifications.

For example, a company may have government or corporate contracts, copyrights, or patents that could be challenging to assign. A stock sale could be a better solution because the company, not the owner, will retain the ownership. Also, when a company is dependent on a few prominent customers or vendors, the stock sale can reduce the risk of losing these contractual agreements.

Sellers often favor stock sales because all the proceeds are taxed at a lower capital gains rate, and in C-corporations, the corporate level taxes are bypassed. 

Defined benefit plan or cash balance plan

So now, let’s get back to what happens with your defined benefit plan or cash balance plan. As stated above, the company carries on with a stock purchase as it usually would. So there was actually no change to the retirement structure. It would still cover the employees and potentially any compensation for a new owner.

But the existing owner would be terminating their employment with the company and, as such, would roll any vested balance over into their IRA. The seller should make sure that they give the buyer the plan documents and make sure that they still want this plan to carry forward. 

The buyer does not want to continue with a defined benefit plan in many situations. This is often the case if they are a smaller, more non-sophisticated hire who does not understand the complexities of these plans. 

Alternatively, it could also be a large acquirer who already has a different structure in place. This may these employees may be covered under the control group rules. But in either event, make sure discussion of the plan is brought up in the acquisition paperwork.

But under an asset purchase transaction, the plan will still stay with the old company. The old company now would have no assets or possibly limited assets that weren’t part of the sale. The owner might continue to use the corporation for operating another business. 

It is also common for a business acquirer to undertake a consulting agreement with a seller to pay them a certain amount as an independent contractor consultant. This money can then go to the old company still owned by the seller. As such, the seller can continue to use the defined benefit plan as a tax deferral on this additional consulting income.

However, even though the seller might choose to keep the plan for additional operations, they still need to terminate and pay out the employees covered under the defined benefit plan. In most situations, these employees will become immediately vested, and balances can be rolled over into individual IRAs.

As you can see, how a business transaction is structured is critical to determining what happens with the defined benefit plan. Make sure you consider these issues upfront.

Final Thoughts

Generally, more minor business sales are usually structured as asset purchases. The buyer gets the tax advantages and does not assume any liabilities. However, many are structured as stock sales for larger companies with a well-known brand and many existing contracts. 

Each business transaction is unique, and buyers and sellers should consult with their CPA and attorney to ensure the transaction is structured correctly. 

Market Based Cash Balance Plan: The ‘Simple’ Guide

Market-based cash balance plans are a twist on our favorite retirement structure. They have been used extensively for certain employers but have been overlooked by many others.  

This plan allows for sharing investment risk, similar to how it’s done in a defined contribution plan. 

Since their introduction, MBCB plans have grown popular among professional service organizations and partnership groups. Yet many companies have basically ignored them. They go with a traditional cash balance plan or just stick with a safe harbor 401k plan.  


Cash balance plans accrue benefits that are payable at a future date. Like a defined contribution plan, the employee’s benefit is based on the value of their “individual” account.

Market-based plans are a type of cash balance plan where the account’s growth is tied to the actual return on plan assets. This contrasts with a traditional cash balance plan that typically has a fixed interest credit rate.

Market-based cash balance plans are popular with professional service businesses with many partners. This included physician groups and law firms.

Cash balance plans must have an investment vehicle to accumulate assets and pay benefits when they become due. An essential part of the administration of a defined benefit plan is the oversight of transactions occurring during the year.

Investment Options

This is accomplished through an asset reconciliation, and it is a process by which potential issues are discovered and resolved. This chapter will review the different components of asset reconciliation. We will explore the difference between the use of market value and smoothed value of assets.

In addition, there will be an overview of how asset reconciliation is used to determine the rate of return, which is required for both funding purposes and government forms. This chapter will provide an overview of varying types of investments.

The named trustee in the plan document is ultimately responsible for managing the investments, delegating this responsibility, and hiring and monitoring investment service providers that assist in this regard.

Rate of Return

The rate of return is the percentage increase in the asset value due to investment performance. In general, there are many ways to calculate a generic investment return. However, we are referencing a specific method that the IRS requires for this discussion.

It considers cash flow through the year (such as benefit payments, expenses, and contributions). It measures how well the assets increased due to investment activity. It is usually determined for one year.

chart with finance, tax and debt

Depending on the plan’s asset allocation, the expected asset return will be higher or lower than the actual asset return. If it is invested conservatively, then the actual rate of return should be stable, eliminating volatility that produces very high or low returns.

In other words, investing conservatively should eliminate deviation and produce a relatively steady rate of return. On the other hand, if the assets are invested aggressively (e.g., 100% in stocks), the expected return will likely be more volatile and could produce more significant swings in actual return or loss.

Review of the Calculation

In the simplest example, if there is $1,000 at the beginning of the year and $1,100 at the end of the year, then the rate of return is determined to be (1,100/1,000) – 1 = 10%. There are no contributions, benefit payments, or expenses in this example.

For determining the rate of return, it does not matter if the return was a result of interest, dividends, or appreciation. Only the market value of assets is considered.

The rate of return is needed so that the plan’s funded status can be explained from year to year. If asset returns are less than expected, the plan’s funding must generally be increased to compensate for the low return. This means that additional employer contributions will be required to pay for the poor asset performance.

The rate of return is also needed during the actuarial valuation for determining funding balance amounts. In addition, if the plan sponsor would like estimates of future funding levels, future rate of return estimates must be used for a market based cash balance plan.

The first step in determining the rate of return is to perform a thorough asset reconciliation. The rate of return is a time-weighted return that considers the actual date of the transactions during the plan year.

Fixed-Income Investments

Fixed income investing is an investment that pays a set interest rate. This is because governments and companies use it as a means of raising funds for large projects or operations.

Fixed income investment vehicles are not like savings accounts, in that they require a regular withdrawal. You may have to surrender some of your investment at maturity or risk paying a penalty. Another risk is interest rate risk, which means you may lose money if the interest rates in the market change.

Fixed income investments can be made by borrowing money from the federal government and other financial institutions. The federal government issues Treasury bonds and is arguably the safest type of bond for fixed income investing, because they have a long maturity.

In contrast, high-yield bonds, also known as junk bonds, are more risky. They tend to offer higher interest payments than investment-grade bonds. However, you can diversify your investment portfolio with these investments.

As retirement approaches, advisors often recommend allocating some of your investments to fixed income investments. This reduces your overall risk and simplifies retirement budgeting. This works well in a market based approach.

But if you are worried about the volatility of the market, fixed income investments may be right for you. While you should keep in mind that bonds do have some risks, they are much lower than stocks.

Building a Diversified & Conservative Portfolio

Choosing a conservative dividend portfolio can help you achieve your investment goals. The average yield of a DGI portfolio is 3%, and it takes about five years for it to start throwing you income in the 4-5% range.

Dividend reinvestment and yearly dividend increases will increase your starting yield. Investing in REITs and higher yielding, safe stocks will also help. But remember that there is a risk. Dividends can go down as well as up, so you should be able to tolerate them.

A conservative dividend portfolio will also have some commodity exposure. While such investments may seem risky, the beta on these companies is so low that you can have substantial exposure to them.

While the initial bond / stock mix depends on your risk tolerance and return goals, there are certain benchmarks that you can follow to achieve meaningful income in retirement. A conservative dividend portfolio consists of quality dividend stocks that collectively yield 3% or more and increase their dividends by 3.5% annually.

This yield is high enough to offset the risk of inflation and still maintain a high income stream. With a little work, you can build a conservative dividend portfolio that yields between 4% and 4.5%. By doing this, you’ll have income security and diversification without the risk of losing your nest egg.

Another good option for a conservative dividend portfolio is to invest in insurance companies. This sector has many advantages over other types of investments, but it is riskier. BP shares, for example, were hit the hardest by the spill of oil in the Gulf of Mexico, and many investors who had a five-year portfolio were able to withstand the shock.

Market Based Cash Balance Plan Allocation

Asset allocation between bonds, stock, and cash is a plan sponsor’s decision. The formula for the rates of return is:

Rate of return = (I) / (A + C – B – E)

Where I is the investment return during the year, including an offset for investment expenses; A is the beginning of year market value; B is the weighted value of distributions; C is the weighted value of the contributions, and E is the weighted value of the administrative expense.

Each transaction must be weighted for the time between the transaction’s date and the end of the year. Let’s take a calendar year example: if the transaction occurred on April 1, then the weighting would be ¾; on July 1, then the weighting would be ½; or on October 1, then the weighting would be ¼. The transaction amount is then multiplied by the weighting to determine a weighted value.