Cash Balance Plan FAQ: The Questions You Never Thought to Ask ✅


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Cash balance plans are not always the easiest plans to understand. They are one of the best qualified retirement plans, but that doesn’t alleviate many of the questions. That’s why we have developed the cash balance plan FAQ.

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1) Can a Cash Balance Plan Be Rolled Over into an IRA?

Among the many questions often asked about qualified retirement vehicles is whether they can be rolled over into an IRA.  With a cash balance plan, you can roll over your funds into a rollover IRA as seen fit.

Why would anyone want to do this?  It is assumed that as circumstances change in one’s life, potential job changes are going to happen.  When one leaves his or her job position at a former employer who offered a cash balance plan, they need to have options on where to put it should they leave.

2) Can you borrow from a cash balance plan?

Yes you can. Because cash balance plans are deemed qualified IRS plans they are subject to the loan guidelines. You can borrow the lesser of 50% of your vested account or $50,000. Remember that most cash balance plans have a vesting schedule and the loan can only be based on the vested portion.

3) Is a Cash Balance Plan a Defined Contribution Plan?

While it may sound like a cash balance plan meets that definition of a defined contribution plan, the reality is that a cash balance plan is not considered a defined contribution plan, but a defined benefit plan.

A defined benefit plan is a retirement plan that is taken care of by the employer, for the benefit of the employee.  Rather than an employee making regular contributions, the employer contributes to the plan for the employee based on their compensation.

For a cash balance plan to be considered a defined contribution plan, the employee would need to make regular contributions themselves, usually done by withholding a small portion of their monthly paycheck. Since the employer is contribution to a cash balance plan for the employee, a cash balance plan is considered a defined benefit plan, and not a defined contribution plan.

4) Are Cash Balance Plans Qualified Plan?

When referring to a “qualified” retirement plan, that simply means whether the plan gives the consumer any tax qualified breaks, such as tax free or tax deferred.  Another benefit of qualified plans is that they are protected from any creditors in the event of bankruptcy.

A cash balance plan is considered an IRS-qualified retirement plan, and thus has the protection from creditors should you file bankruptcy.  It also has tax breaks for the employer and the employee. The employer gets a deduction for the amounts contributed, and the employee gets to let the account grow tax deferred.

5) How Does a Cash Balance Plan Work?

A Cash Balance Plan is a retirement vehicle offered by an employer for certain employees meeting eligibility requirements.  Usually these eligibility requirements fall within being a part owner of the company or a high-end executive within the company. Here is an example of a plan.

Companies that offer the plan will contribute a set amount of funds set aside for retirement.  The amount of funds used are based on a percentage of the employee’s annual compensation.  These funds are typical professionally managed by a investment firm, which will investment the funds in stocks bonds, mutual funds and even insurance.

The employer offering a cash balance plan also contributes an interest fee charge, which is defined in the plan documents.  This gives the employee the benefit of a steady and conservative growth of their funds.

The funds of a cash balance plan are put into a “hypothetical” account for each employee. Each employee receives a year end statement with amounts contributed and total balance. All contributions are based on the employee’s yearly compensation.

Cash balance plans work very similar to a traditional defined benefit plan, with a few differences named above.  Pension plans are retirement plans offered by employers that guarantee a certain percentage of their salary to be paid out during their retirement.  They offer a yearly ongoing contribution plus interest fees to be contributed toward retirement.

6) Can you take money out of a cash balance plan?

Yes but you can only withdraw your vested account balance. For example, if you have only worked for the company for two years and the plan has three year vesting then you will not be able to take the balance with you.

However, many plans are set up by small business owners. If they decide to terminate the plan the plan will become fully vested. As such, they will be entitled to roll over the entire balance into an IRA.

7) Are Cash Balance Plans Taxable?

Like most qualified retirement plans, cash balance plans are considered tax-deferred retirement vehicles.  This simply means taxes are not immediately paid upon contributing funds but are paid when funds are withdrawn.

The funds within the account grow tax deferred as well, so no taxes are necessary on the annual growth of the fund.  When funds are to be withdrawn during retirement, the funds are taxed as ordinary income.

8) What about a Cash Balance Plan Investment Strategy?

The plan assets will typically be invested by an investment advisor or financial planner. But the advisor will have flexibility when examining investment options. For example, most plans will invest in stocks and mutual funds.

But life insurance can be a great investment tool in a plan. However, there will need to be investment valuations performed at the end of the year so that the actuary can perform the necessary contribution requirements.

9) What are the advantages of a cash balance plan?

The main advantage to the employer is the higher level of contributions that can be made to the cash balance plan on a tax-deferred basis. Contributions to defined benefit plans are completely exempt from taxes up to a target income of $225,000 per individual for 2019.

For a small business, this can be a significant advantage, particularly if the business does not meet the requirement to qualify for a qualified business income (QBI) deduction, or if the owner wants to make significant tax-deferred contributions before retirement.

If contributions to a cash balance plan are enough to bring QBI to the level required to qualify for the deduction, a cash balance plan can result in significant tax savings to the business owner. For 2019, QBI is $315,300 for married couples filing jointly, $207,500 for heads of households and $157,500 for single filers. Business owners can deduct an automatic 20% from earnings that fall below these brackets.

Cash balance plans are also cheaper for business owners – instead of struggling to meet pension funding requirements based on salaries for employees at the last years of their service, an employer can contribute a set percentage of the employee’s wage each year.

Advantages to the employee include a hands-off retirement plan that they are not responsible for contributing to. The plan is fully administered and investing choices are handled by professional investors. Cash balance plans are also fully portable – if the employee chooses to leave the company for any reason, they may roll the balance of the funds tax-free into an IRA.

Cash balance plans are also insured. The risk of market fluctuations is placed with the employer, and the employee does not risk losing the investment due to changes in the market valuation.

10) What are the disadvantages of a cash balance plan?

Disadvantages to a business owner include the cost and complexity of plan administration. A certified actuarial must value the plan each year and Form 5500 is required to filed with the IRS on a yearly basis to show that the plan is fully funded.

These costs can be several thousand dollars each year, in addition to the actual contribution cost of the plan. For an employee, the disadvantage lies in the lack of control of investment choices or contributions. The employee may not contribute to the plan; that responsibility lies with the employer.

For employees who wish to contribute more funds towards retirement and have the means to do so, this means they must look at investment options using after-tax dollars. Rarely, employers may offer both cash balance plans and 401(k)s, which allow the employee to contribute tax-deferred monies towards retirement.

11) I recently retired and am entitled to a lump sum from my cash balance plan or a regular annuity. What should I do?

This decision must be made on the basis of your expected needs. Some individuals choose to roll their plan into an IRA so that they may continue to gain earnings based on their investment. Others choose to take a lifetime annuity. However, the decision must be carefully made to fit the retiree’s future needs.

12) My defined pension plan was recently converted to a cash balance plan. What does this mean for my retirement?

If your defined pension plan was recently converted and you have been working for many years for the same company, this can result in a decrease in the benefit you will have at the end of your retirement.

This is because traditional pension plans had defined payouts that were calculated based on the number of years of service and the last few years of earnings at the company; cash balance plans are based entirely on contributions and a defined interest percentage.

It is typical to see a 15% decrease in plan benefit for long-time employees whose plans were converted from a traditional pension to a cash balance plan. However, newer employees who have many years remaining to earn funds in their cash balance plan will not experience a decrease in expected benefit, since the contributions to their plan will have time to grow through the years and a target benefit is set at their initial onboarding to the plan.

13) What are the differences between a traditional pension and a cash balance plan?

The main difference between a traditional pension and a cash balance plan is that a traditional pension bases the final payout on years of service and the salary in the last few years of employment. In contrast, a cash balance plan promises a set amount of money at retirement, and earnings invested over time are compounded. Cash balance plans are portable – they can be taken with the worker if they leave prior to retirement and rolled into an IRA.

14) What Is a Cash Balance Plan Pension Scheme?

A common term among pension plans is a “pension scheme”. A pension scheme is simply a savings plan to help one save money for later life events. They usually have favorable tax benefits when comparing to other savings plans.

A cash balance pension scheme is simply another term for a cash balance pension plan. It is considered a defined pension plan because it is a benefit offered by and contributed to by your employer, very similar to a traditional pension plan.

Because money that is contributed to a cash balance plan, designated to be money for later life events, a cash balance plan is often referred to as a Cash Balance Pension Scheme. Any type of savings plan where money is contributed to for later life events can be considered a pension scheme.

Summary

Cash balance plans provide the most benefits to business owners who are seeking ways to reduce taxes and greatly increase their retirement savings. If they can be used in tandem with a 401(k) plan, the tax savings and retirement contributions can be quite high. From an employee perspective, having the option for both plans allows some control over retirement planning and provides a platform for greater savings in future years.

Paul Sundin

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