Cash Balance Plan Distribution Options: How to ‘Avoid’ Mistakes

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Cash balance plans are great for making large tax-deductible contributions. But what do you do when you are done funding? In this post, we will discuss the cash balance plan distribution options.

A cash balance plan distributes benefits based on the credits a participant has accumulated over time. The amount is usually a percentage of salary or a variable linked to an index. Each year that a participant is employed, their credits accumulate.

At retirement, they can choose to receive a lump sum payment, roll over the lump sum amount, or elect to receive an annuity. These options are all equally beneficial and require no additional tax planning.

After that, the employer cannot reduce the amount of contributions. The employee can terminate their employment at any time during the year without affecting their eligibility. Here is a quick summary and then we can dive into the details.

Cash Balance Plan Distribution Options:

As a general rule, the vested balance in a cash balance plan can be distributed as a lump-sum or rolled over into an IRA or 401(k) upon the employee’s retirement or when they leave the company. In some cases, they can elect an annuity where the employee receives a set monthly amount.

Distribution options

Some background

Cash balance plans are technically a type of defined benefit plan. Annual contributions are based on a variety of factors. This includes yearly compensation, age, length of service, and potential employment factors.

Another benefit to implementing a cash balance plan is the funding comes directly from the employer. Not only that, the employer assumes the investment risk.

The employer bears all the risks associated with the cash balance plan. If the plan does not give the anticipated returns, the employer has to chip in to make an unanticipated contribution. The contributions towards a plan do not change even during financial difficulty.

This can ruin a company and should be considered clearly when setting up a cash balance plan. 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.

The amount of benefits available under a cash balance plan is calculated according to the number of credits the participant has accumulated in the plan. The number of credits depends on the type of cash balance plan and the demographics of the employee. Contributions are required from the employer after 1,000 hours of employment.

How is a cash balance plan distributed?

Typically, the vested cash balance plan amount can be paid as a set monthly payment, a lump-sum distribution or simply rolled into an IRA upon the employee’s retirement or upon plan termination.

There are two main types of cash balance plan distribution options: a lump sum and an annuity. The former option is more desirable for retirement since it allows the participant to receive a lump sum payment that is equal to the accrued benefit.

The latter option is more favorable for those with limited incomes or those with poor health. Regardless of which option is selected, the benefits will always be invested in the best way available.

Cash Balance Plan Distribution Options

The cash balance plan is similar to a traditional defined-benefit plan. The employer contributes a set amount per employee, which is based on the value of the employee’s contributions in the current year.

As a result, the employer is in charge of investing the money in the plan. In addition to the benefit, a cash balance plan can also be used to provide profit sharing contributions. As a result, both the employer and the employee are rewarded equally.

What are the distribution options?

In addition to a lump-sum distribution, there are also two types of cash balance plan distribution options. A hypothetical account may be available before retirement. Other options are available in case of disability or death. A lump-sum distribution is also possible.

A cash balance plan can be used as a primary retirement savings option. The key to choosing the best plan is to choose a defined benefit option that suits your needs. It should not be difficult to understand and implement.

A cash balance plan provides the participant with various distribution options. The participant can access their funds before retirement or when their circumstances require it. The other option is the annuity. In this case, the participant receives the entire account balance at once.

Contributions over $100kHigher fee structure
Flexible funding requirementsMandatory plan funding
Tax-favored contributionsPermanent retirement plan
Custom plan design rulesConservative investments

The monthly payout gives the participant the option to withdraw a lump sum at anytime. A cash balance pension can be accessed at any time and is highly versatile. It can be a great option for those who are nearing retirement and do not want to depend on a pension.

When can you withdraw from a cash balance plan?

One of the benefits of a cash balance plan is that if an employee leaves their job, they can rollover their remaining vested balance into an Individual Retirement Account (IRA) without any tax consequences.

These benefits are particularly valuable for people who are leaving a company that provides a pension because they can transfer a lump sum distribution tax-free to an IRA. If you’re considering rolling over your cash balance plan, it’s crucial to understand the rules and procedures of this type of transfer.

Financial planning puzzle piece

Once you’ve chosen the IRA or 401k, you can choose how to roll over your cash balance pension plan. You can also opt for annuitizing your cash balance plan, which means you’ll get smaller payments over time. If you’d prefer a lump sum payment, you can also choose to roll it over to your IRA or to your new employer’s plan. The best way to move the funds into a Roth IRA is to do a direct rollover.

The IRA rollover

The process for a cash balance plan rollover to an IRA is simple. You can choose whether to use the traditional IRA or a Roth IRA. The traditional IRA requires that the funds have already been taxed, while a Roth IRA requires that the beneficiary of a cash balance plan must pay taxes on the amount rolled over.

A cash balance plan rollover can be made to almost any qualified retirement account. The most common choice is an IRA, while a 401k rollover is the second most popular option.

The cash balance plan distribution options include a cliff or graded schedule. These may be advantageous or disadvantageous to the employee, but they are more cost-effective than 401(k) profit-sharing plans. Unlike a 401(k), a cash balance plan’s contribution limits are much higher and the benefits are much more tangible. The plan actuary will take these factors into consideration before determining the final payout of a cash balance plan.

Advantages ✅Disadvantages ❌
Ability to Roll into IRA or 401(k)Complex IRS Rules
Min/Max/Target Funding RangeHigher Administration Fees
Large Contributions ($100k +)Permanent Plan Design
Substantial Tax DeductionsTaxable Withdrawals

How to complete a cash balance plan distribution

Here are the 5 steps to a cash balance distribution:

  1. Determine which retirement account to process the rollover

    Remember that cash balance plans are excellent options when making large annual contributions. But when the business income is lower, then you could consider terminating the plan. Once terminated, you have many distribution options.

    Make sure that you don’t take any funds out to spend. If you do, you will be taxed at ordinary tax rates. You could also have a 10% penalty if under age 59 1/2. That’s why distributing funds into an IRA is the favored option.

  2. Consider a lump sum distribution

    A lump sum option is available. Plans are technically set up to provide a certain annuity at retirement. But the reality is that most plans will be terminated long before retirement benefits are paid out. The funds are typically rolled over into an IRA.

    The plan does have the option to set up an annuity that can pay benefits over a participant’s life. Upon plan termination, assets can be used to acquire an insurance annuity. But often, employees choose to take a lump-sum distribution.

  3. Process the IRA rollover

    Completing the IRA rollover is relatively straightforward. This is the case as long as you’re transferring it between the same custodian. For example, if you had your cash balance plan at Fidelity, then you can open up an IRA at Fidelity and transfer the funds right over. There is also a 1099 that is completed at the end of the year.

  4. Don’t forget about a 401(k)

    While the popular option is to distribute funds into an IRA, you can also distribute funds into a 401(k). In fact, you can distribute funds into any qualified plan. As long as it is a direct custodian transfer and you don’t distribute funds to yourself, you are fine.

  5. Examine investment options

    Once your investments are outside of the cash balance plan, you have a lot more flexibility. You no longer need to live by the 5% interest credit rate, and you have the flexibility to earn higher returns. In addition, volatility it’s not a problem inside an IRA or 401(k). Eliminating the volatility can be one large reason to terminate a plan.

Final takeaway

A cash balance plan offers guaranteed monthly payouts in the form of a life annuity or a lump sum at retirement. The annuity attached to a cash balance plan must meet certain requirements in order to qualify for tax advantages.

The benefits of an annuity are generally higher than those of a lump sum. In contrast, a company-sponsored plan can provide a guaranteed monthly income for its employees and may benefit from a company-sponsored pension.

Paul Sundin

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