Cash Balance Plan Eligibility: Top Strategies [+ IRS Hazards]


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Cash balance plan eligibility is a big concern for many business owners. Most people are OK contributing a specified amount for their employees. They just don’t want to be stuck with a contribution they can’t afford.

For this reason, employee eligibility can make or break a plan. The regulations spell out specific minimum standards that each employer must meet.

In this post, we will detail the eligibility requirements and explain a few provisions that you can use to your benefit. Let’s get started!

Background

If you’re in the market for a new retirement plan, you may want to consider a cash balance plan. These plans offer an inexpensive option for retirement benefits for most entities.

Cash balance plans credit a participant’s account each year based on his or her compensation. A typical example is a participant with a $100,000 account balance at age 65. That person would then be eligible for a monthly amount of ten thousand dollars a year for the rest of his or her life.

However, it’s also possible to take a lump sum benefit if the account value were lower. In that case, the employer would bear the investment risk, while the participant would receive the lump sum.

chart with finance, tax and debt

While they differ from 401(k) plans, they are similar in their structure. A 401(k) plan guarantees a fixed monthly benefit, while a cash balance plan guarantees a specific amount.

Most allow participants to roll vested balances into another type of retirement plan, such as an IRA or 401k. You can also roll the money if you leave your employer. But before you make a move, you need to know what you need to do to be eligible.

As long as the employer is willing to make the full contribution, the cash balance plan is an excellent choice for most businesses. However, there are some caveats. As with any other retirement plan, the key to cash balance plan eligibility is knowing what the plan is and how much it will cost.

What is the Cash Balance Plan Eligibility?

There are many rules and requirements for these plans. But let’s point out the top three cash balance plan eligibility requirements:

  • Age restrictions. Cash balance plans have age restrictions. You are allowed to exclude anyone under age 21 from eligibility.
  • Year one exclusion. You can also limit the number of employees by requiring a specific amount of time before participation. For example, you can use a one-year service requirement to reduce eligibility if you have a company with a high turnover rate.
  • Minimum hours. You can restrict participation based on the number of hours worked during the plan year. The company can limit the plan to only those employees that work over 1,000 hours.

The entrance date is when a plan allows employees to enroll once the service conditions and age requirements are met. Typical entrance dates are monthly, quarterly, semi-annual or annual.

Companies with large employee turnover may desire to keep transient employees off their plan by making an annual service requirement. This is the most restrictive timeline that is eligible under the regulations.

Specific eligibility requirements

A computation period is a time period of 12 consecutive months selected by the employer. It is defined in the plan document. A plan must designate a computation period for measuring years of service for eligibility, vesting and benefit accrual except if the elapsed time method is selected.

For example, the years of service or participation an employee earns will be dependent upon the number of hours worked for the duration of the computation period.

A year of participation (or credited service) can be any consistent 12 consecutive month period designated by the plan. Under Department of Labor (DOL) regulations, a plan is not required to take into account any such 12-month period during which the employee has fewer than 1,000 hours of service.

Because of this rule, normally, a plan requires the participant to complete at least 1,000 hours of service in a year in order to qualify for a year of credited service. However, a plan can be more liberal by requiring less than 1,000 hours for a year of credited service.

Hours of Service Alternatives

Other alternatives exist and defined benefit plans offer great flexibility to plan sponsors. Seasonal industries, in particular, may require a reduced number of hours of service. A plan may require more than 1,000 hours of service for a year of benefit accrual (e.g., 2,000 hours) provided that prorated accruals are credited for those with fewer than the required hours but more than 1,000 hours. This proration can only be made in plans with certain types of benefit formulas.

For example, a fixed benefit of $50 per month per year of participation could use a proration.
A plan that establishes benefits on the basis of hours worked or compensation received generally could not use proration since the accrual has already been prorated by adjusting for hours worked or compensation received.

How does eligibility work?

The benefits accrued in a cash balance plan are subject to income taxation when withdrawn during retirement. This means that maximizing the tax benefits of a cash balance plan requires careful analysis of your future tax situation.

However, if you make the right decisions, you’ll enjoy the best possible retirement. If you’re unsure, you can work with your employer to determine how much you need to contribute and make the most tax-efficient contributions.

Vesting requirements

Recent IRS tax changes have clarified vesting requirements of cash balance plans. Generally, cash balance plans have more restrictive vesting schedules than other qualified plans. However, vesting schedules can be favorably structured.

All plan participants must be 100% vested after three years of plan participation. As a result, most plans are established with three-year vesting.

This means that participants are not vested at all in any plan contributions until they reach the third year of service. At this point, they are 100% vested. If any participant is terminated before the third year of service, all contributions are then forfeited and can be used to reduce future contributions.

EligibilityRestriction
Minimum hoursEmployees must work at least 1,000 hours a year to qualify for participation.
Age restrictionsEmployees must be at least 21 years old to participate.
Entrance dateYou can exclude employees who were hired during the year.

Final thoughts

A cash balance plan can complement your existing 401(k) plan or be a standalone retirement plan. It’s important to understand what the maximum payout amounts are.

Cash balance plans are hybrids between defined benefit and defined contribution plans. Instead of a fixed benefit plan, they allow employees to build massive retirement assets. Because they are employer-sponsored, they are open to virtually any type of business.

It may vary depending on your age and the compensation you’ve received in your career. However, in general, a cash balance rollover is done by rolling it into an individual retirement account.

Paul Sundin

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