Cash Balance Plan Meaningful Benefit: The Complete Guide [+ Tips]


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If you know anything about cash balance plans, you know that there are many IRS rules to follow. One of them is the cash balance plan meaningful benefit rule.

What is this rule and how does it work? In this post, we will show you how it works and offer you some tips on how it works in the real world. Let’s get started!

Background

Cash balance plans can be a great way to provide a meaningful benefit to employees. The amount that employers can contribute to the plan varies depending on how many years of service the employee has and their compensation.

If you’re thinking of implementing a cash balance plan, you should consider the legal requirements and risks. Cash balance plans are defined benefit plans, according to IRS regulations. This means that the tax benefits are based on an ongoing employer’s contribution to the plan.

This credit can be expressed in either a dollar amount or a percentage of the participant’s income. If you have a cash balance plan, the benefits will be based on the total amount of the employer’s contributions.

What is a meaningful benefit?

According to the IRS, cash balance plans must provide a meaningful benefit to a minimum of 40% of the non-excludable company employees. This requirement falls under IRC Section 401(a)26.

The IRS states that “meaningful” applies to a plan participant whose annual plan credit results in at least a 0.5% benefit accrual. 

For the calculation, the participant’s credit assumes the plan’s normal retirement age and utilizes the specified interest crediting rate, which converts to the corresponding benefit accrual rate.

If the plan’s interest crediting rate is defined as the plan’s investment rate of return and is deemed too low, an employee accrual rate could be less than 0.5% and might not be assumed to benefit from passing the test. If enough participants do not meet the 0.5% threshold, the plan will likely fail the test.

Plan eligibility would generally have to expand to include other participant groups in this situation. Alternatively, benefits might have to increase to enough of the participants to meet the 40% threshold under IRC 401(a)26.

How the meaningful benefit works?

We just mentioned that a cash balance plan must provide a “meaningful benefit” to participating employees. So, what does “meaningful” mean?

According to the IRS regulations, it is an accrued benefit of at least ½% of pay a year. The IRS does specifically say that a ½% cash balance plan credit must be made. But it is a credit large enough to generate a ½% benefit upon retirement.

The current ½% pay credit would then translate into approximately 2% to 4% of current employee pay. This will vary depending on age and salary. For example, if a participant makes $80,000 a year, a ½ percent benefit would amount to approximately $1,600 to $2,400.

The plans allow for groups and age-weighted contributions. You can give a larger contribution to older employees and smaller contributions to any young employees. This may make sense if the owner has more senior employees who have been with the company for many years and would like to reward them for their commitment to the company.

Other rules may apply. The plan may fail the meaningful benefit test if the IRS determines the plan solely exists to provide benefits to a select employee group.

How to apply benefit test

Here are the 5 steps to applying the meaningful benefit rule:

  1. Determine eligible employees

    Remember that you can exclude employees under age 21, who work less than 1,000 hours and who were hired during the current year. The benefit rule is only applicable to eligible employees, so normal turnover can help you allocate a lower benefit and still be compliant.

  2. Apply Pay Credit

    You have a wide range of pay credit rates available to you. Most plan documents will use a percentage of pay. But the second most popular option is a flat dollar amount.
    Whatever option is chosen, it should be documented in the plan document. The company can revise the pay credit as long as the anti-cutback rules are not violated. Essentially, you can’t reduce a pay credit that the employee has already earned.

  3. Verify Top Heavy Rules

    Top-heavy rules are applicable under IRC 416. The benefits for employees that are not highly compensated must be increased if benefits for the highly paid are too excessive. The plan specifies the pension age and can vary from plan to plan.

  4. Determine Accrued Benefit

    Under defined benefit plan rules, employees or participants receive vested accrued benefits. The benefits should be received no later than the 60th day after the plan year’s end when they have been employed for ten years or decide to leave a job. When an employee leaves the job, the benefits earned to date are frozen and held in trust until retirement age if they don’t choose to take a lump sum or roll over to another pension plan.

  5. Review with TPA

    Your TPA and actuary will be the ones who will apply the benefit testing. It is just one of many tests that must be applied. You can actually pass the meaningful benefit test and still fail other tests, such as gateway or average benefit.

BenefitFormula
Minimum 40% of non-excludable employeesFixed or percent
Falls under IRC Section 401(a)26IRS prescribed rules
At least ½% of pay a yearNormally 2% to 4% pay credit
Other testing appliesFlexible (subject to testing)

Most administrators will provide a comprehensive illustration showing eligible employees, contribution levels, and vesting requirements. Any cash balance retirement plan illustration should encompass all criteria.

Bottom line

A cash balance plan is not suitable for every practice. The benefit may not be appropriate for a small business with part-time employees or high turnover of employees. You must also consider the entrance date for the plan.

As we have stated, these plans are complex and have many rules and regulations that must be followed. That’s why selecting a qualified administrator should be your biggest concern.

There are many TPAs in the market. But many just don’t understand how these plans work and how to best structure them. Do your due diligence.

Paul Sundin

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