You many have heard about a cash balance plan by now. But are you aware of all the cash balance plan advantages?
These plans do have a few pitfalls. But for many business owners, the advantages far outweigh the downsides.
In this post, we will cover all the plan benefits. That way, you can make the decision as to whether a plan is right for you and your business.
Table of contents
How does a plan work?
A cash balance plan is a special type of defined benefit pension plan that is designed to provide retirement income for employees. It is funded by contributions made by the employer, and the benefits are typically paid out in the form of a lump sum or an annuity upon retirement.
In a cash balance plan, each participant has an individual account balance that is credited with a fixed percentage of their pay each year, as well as additional interest credit. The account balance is portable, meaning that it can be transferred to another employer or to an individual retirement account (IRA) if the employee leaves the company (assuming vesting is met).
Cash balance plans have been controversial in the past, as some advocacy groups have argued that they disproportionately benefit higher-paid employees and may be less generous than traditional pension plans. However, cash balance plans are legal and can be a useful way for employers to provide retirement benefits to their employees.
Cash Balance Plan Advantages
A cash balance plan is a defined benefit pension plan that combines elements of traditional defined benefit plans with those of defined contribution plans, such as 401(k)s. Cash balance plans offer several advantages for employers and employees, including:
- Predictable cost: Cash balance plans provide a predictable cost for funding retirement benefits, which can be helpful for budgeting and financial planning. The employer must contribute a fixed amount to each employee’s account, typically based on a percentage of salary or a fixed dollar amount.
- Customization: Cash balance plans can be customized to fit the needs of the employer and employees. The employer can choose the contribution rate and the formula for calculating the guaranteed rate of return, and they can allocate their contributions among investment options.
- Portability: Cash balance plans offer portability, which means that employees can take their account balance with them if they leave the company. This can attract younger employees who may change jobs more frequently.
- Tax benefits: Cash balance plans offer tax benefits for both employers and employees. Employer contributions to the plan are tax-deductible, and the investment earnings on the account balance are tax-deferred, allowing employees to save on taxes until retirement.
- Simplicity: Cash balance plans are generally simpler to administer than traditional defined benefit plans, which can benefit small businesses with limited resources.
Cash balance plans offer a combination of predictability, customization, portability, and tax benefits that can be attractive to employers and employees. It is essential for employers and employees to carefully review the terms of the plan and consult with a qualified professional to ensure that it meets their needs and is in compliance with all relevant laws and regulations. They are several cash balance plan advantages for the right company.
Who are a good fit?
A cash balance plan may be a good fit for an employer looking for a retirement plan that offers a combination of defined benefit and defined contribution features. A cash balance plan is a defined benefit pension plan that combines elements of traditional defined benefit plans with those of defined contribution plans, such as 401(k)s.
Here are some factors to consider when determining whether a cash balance plan is a good fit for an employer:
- Size of the employer: Cash balance plans are typically more suitable for larger employers with a stable workforce looking for a predictable, long-term retirement plan.
- Employee demographics: Cash balance plans may be a good fit for employers with a diverse workforce, including employees at different career stages.
- Financial stability: Cash balance plans may be a good fit for employers who are financially stable and able to commit to the required contributions to the plan.
- Employee retention: Cash balance plans may be attractive to employees due to their portability, which means that employees can take their account balance with them if they leave the company. This can be particularly attractive to younger employees who may change jobs more frequently.
Overall, a cash balance plan may be a good fit for an employer looking for a retirement plan that offers a combination of defined benefit and defined contribution features and who, has a stable workforce and is financially stable. It is essential for employers to carefully review the features and requirements of a cash balance plan and to consult with a qualified professional to determine whether it is the right fit for their business.
Maximizing the Tax Benefits
Employer contributions to a cash balance plan are generally tax-deductible for the employer. A cash balance plan is a defined benefit pension plan that combines elements of traditional defined benefit plans with those of defined contribution plans, such as 401(k)s. In a cash balance plan, the employer contributes a fixed amount, or “cash balance,” to an account for each employee, which earns a guaranteed rate of return.
Under the Internal Revenue Code, employer contributions to a qualified retirement plan, including a cash balance plan, are generally tax-deductible for the employer as a business expense. This means the employer can claim a tax deduction for the contribution amount when calculating its annual taxable income.
It is important to note that there are limits on employer contributions that can be tax-deductible. The maximum annual contribution limit for a cash balance plan is the lesser of (a) 100% of the employee’s salary or (b) the maximum annual contribution limit for defined contribution plans, as set by the IRS. For tax year 2021, the maximum annual contribution limit for defined contribution plans is $58,000 for employees under age 50 and $64,500 for employees age 50 and over.
Overall, employer contributions to a cash balance plan are generally tax-deductible for the employer as a business expense, subject to certain limits. Employers and employees should carefully review the terms of the cash balance plan and consult with a qualified tax professional to understand the tax implications of the plan.
There are several reasons why a cash balance plan can be a good option for retirement planning:
- Portability: A cash balance plan allows employees to take their account balance with them if they leave the company, which is not always possible with traditional pension plans. This means that employees can continue to save for retirement even if they change jobs.
- Flexibility: Cash balance plans typically offer a range of investment options, which can allow participants to tailor their retirement savings to their own risk tolerance and financial goals.
- Predictability: The fixed credits that are added to a participant’s account balance in a cash balance plan can provide a level of predictability in terms of retirement savings. This can be helpful for employees who want to have a clear idea of how much they will have saved for retirement.
- Employer contributions: Employers typically contribute to cash balance plans, which can help employees save more for retirement. These contributions can be a significant source of retirement income for employees.
Overall, there are many cash balance plan advantages. They are useful tools for retirement planning, especially for employees who value portability, flexibility, and predictability in their retirement savings. It is important for employees to understand the terms and conditions of their cash balance plan, as well as the potential risks and benefits of participating in the plan.