Cash Balance Plan Investment Strategy: The #1 Option [Video]

You’re ready. You have your plan document and you have the go ahead to fund your plan. But a couple questions still remain. What is your cash balance plan investment strategy and what options do you have investing the plan assets?

You may have heard that there are risks if your plan investment returns are over or under the investment return state in the plan document. But you don’t exactly know about how this works.

In this post, I will give you some guidance on investment strategy and warn you of a few pitfalls. I am not a financial advisor, but at least I can point you in the right direction.

Some background

A wide range of investments is allowed in cash balance plans. These include stocks, bonds, and cash. Each of these may be held directly or through a mutual fund.

More exotic varieties of investment are also allowed. However, plan sponsors should exercise caution when considering varying asset types such as commodities, real estate, collectibles, and derivatives.

The trustee can choose to manage the investments directly or delegate the investment management to a third party. A reasonably standard asset allocation for a defined benefit plan is 60% stocks and 40% bonds. Ultimately the trustee will want an asset mix that closely aligns with expected future benefit payments.

Questionable investments could include paintings, coin collections, baseball cards, and real estate, to name a few. These investments may not meet the trustee’s requirement to act in the sole and best interest of the participants for their benefit.

Furthermore, it may be challenging for the trustee to prove they acted prudently in selecting such an investment. As these investments do not have a well-established market value, do not trade on regulated exchanges, and are not liquid, there may be additional requirements for the trustee, including an appraisal by an independent third party. This will increase the cost and complexity of the administration of a plan with these investments.

What about overfunding or underfunding?

Under a defined benefit plan, assuming all other factors are the same, if the assets produce better than expected returns, the plan sponsor’s contribution will decrease because the earnings on investments will cover more plan liabilities.

If the assets produce less than due returns, the plan sponsor’s contribution will increase because they must make up for the investment loss to cover plan liabilities. A common objective is to have an asset mix covering liabilities, providing a consistent return, and limiting risk in increased contributions to the plan sponsor.

What can I invest the money in?

The good news is that cash balance plans allow you to invest in almost anything. Most plans will be invested in mutual funds, stocks, bonds and CDs. This is just like a 401(k) plan. Employees do not have the ability to “self-direct” assets as all the funds are held in a pooled account.

Most people simply set up an account with their financial advisor or with an online broker like Vanguard, Charles Schwab or Fidelity. You simply open up a pension trust account or retirement trust. It isn’t really a “special” account because it is what you would do essentially to open up a 401k.

Is there a specific cash balance plan investment strategy?

So what type of strategy should you employ with your cash balance plan investments?

Plans are set up with an interest rate credit. So in theory the business owner should attempt to match this amount. But this can be tougher than you might think.

Even though you want nice investment returns, you want to limit volatility. If volatility is low it will not have much impact on your annual contributions.

Get a FREE IllustratioN!

Just give us a little information and we’ll get you a custom illustration in 24 hours.

But be careful with highly volatile investments (Bitcoin is one that comes to mind). If a plan invests in speculative stocks and there is a large decline, this will generally result in larger funding contributions in future years. Essentially, you have to “catch-up” your contributions for the lower returns.

However, the contrary can occur. If the plan has large investment returns, the result can be lower contributions in future years. We all want to have high investment returns, but lower funding levels is not necessarily great for a high earner who is looking to maximize tax deductions.

Do I have to have an annuity?

No. 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 participants life. Upon plan termination, assets can be used to acquire an insurance annuity. But often employees choose to take a lump sum distribution.

Can you invest in real estate?

So maybe you want to get a plan set up but you want to invest in real estate. Can you do this? How does this even work?

Yes you can do this. But before we move any further, let’s clarify that this cash balance plan investment strategy works best for owner-only businesses. Even having your spouse as an employee is okay. If you have employees that qualify for benefits, this plan might be a little challenging to execute.

How to invest the money?

Here are 5 steps you should consider when forming an investment strategy:

  1. Determine if you want a professional advisor or a discount firm

    You might already have a financial advisor or you may just be looking to open an account with Schwab, Fidelity or Vanguard. In either case, make sure you consider your options carefully. You may not have the time to manage the money.

  2. Determine appropriate risk tolerance

    Cash balance plans can use almost any assets class, so make sure to consider your risk tolerance. You generally want to stay on the conservative side. But you can take some exposure to stocks.

  3. Consider different cash balance plan investment options

    Did you know a cash balance plan can invest in real estate and other alternative assets? Determine if these asset classes are appropriate for you. Insurance companies often offer specialized investments such as a Guaranteed Insurance Contracts (GICs), which gives a competitive guaranteed interest rate and provides stable value. Cash may be held in a liquid form to pay current benefit payments.

  4. Don’t forget the interest crediting rate

    Remember that you have an assumed interest crediting rate. In theory, you should try to match this rate. But in practice, it is challenging to mimic the interest crediting rate. But that is fine as long as you don’t have huge volatility in plan assets.

  5. Monitor plan investments

    An annual review should be completed with your financial advisor to make sure that you investments are on track. Investment balances will be evaluated by the actuary at the end of the year and formal appraisals may be required. Ensure that you review the investment portfolio continually to prevent overfunding.

What custodian should I use?

As you know, we are not investment advisors. As such, I’m not going to give you any investment advice or stock tips. Our plans are completely portable and you can use them with basically any provider. This includes Charles Schwab, Fidelity and Vanguard. We can even help you get your account set up with them.

Charles SchwabSchwab makes it easy because we have a representative that we can work directly with when setting up a plan.
FidelityFidelity has been taking much longer recently to set up a new account. But their customer service group has made improvements.
E*TRADEStill the smallest provider. But many people rave about them.
VanguardVanguard is probably the #1 custodian we deal with.

Finalizing your cash balance plan investment strategy

Cash balance advisors play a vital role and can offer flexible investment options on their platforms. These custodians don’t always provide the most diverse investment options, but they will provide for easy set up and administration.

Book a FREE 30 Minute Call!

Schedule a FREE call and we’ll show you how we structure plans for maximum tax efficiency.

Many businesses don’t realize that our plans can be used with any of these providers. Our plan documents can be used to open up an account in as little as a few days.

That allows you to get our structuring and planning services in combination with the cash balance plan investment strategy of the large discount brokerages. So don’t hesitate to consider Vanguard, Fidelity or Schwab.

Bottom Line

So at the end of the day you have plenty of investment options. While you want to maximize your investment returns, try to avoid too much volatility. This can cause wide swings in contribution amounts.

Make sure that you deal with an investment advisor or plat form that understands the investment risks associated with these plans. That way you can sleep at night.

Paul Sundin

Get a FREE 30 Minute Consultation

Reach out to us today and we'll show you our favorite strategies! We can show you how to structure a plan for maximum tax benefit and provide you with a custom plan design.

Leave a Comment