A cash balance plan comes with minimum, maximum and target contribution levels. We recommend funding the target, but how much do you know about the cash balance plan minimum contribution?
When we talk to clients, they often express concern over minimum funding requirements. We know that these plans have plenty of funding upside.
But what happens if a client’s business has a bad year? How can they limit the minimum contribution and still stay compliant?
What is the minimum contribution?
$100,000 or $1,000? Cash balance plans are normally structured to benefit the business owner, but eligible employees will receive a contribution as well. The plans normally require a minimum contribution between 5% and 10% of compensation in the cash balance plan or between a corresponding 401(k) Profit Sharing plan.
In this article, we discuss how to control the required minimum contribution. Let’s get started!
Table of contents
Cash Balance Plan Minimum Contribution
A cash balance plan requires an employer to contribute a certain amount to the account each year. The minimum contribution is usually $1,000 a year. Some employers make higher or lower contributions than others. The amount may be different for employees and business owners. It is important to understand that these contributions are subject to compliance testing.
The amount of the minimum contribution depends on the age of the participant and the amount of income the participant makes. For example, a business owner may be required to contribute $200,000 per annum.
Contributions are taxed the same as 401(k) plans. Depending on age, a business owner can contribute up to $250,000 per year to fund the maximum benefit limit. The amount of the contribution depends on the employee’s income and age.
How to Structure a Plan
If the business owner is younger than 50, the minimum contribution will be lower. An owner may make a smaller annual contribution than an employee. The maximum contribution depends on the age of the employee.
The minimum annual contribution in a cash balance plan is 3% of the participant’s annual income. The employer’s contribution is usually determined by the plan’s funding formula, and it varies from plan to plan.
However, the minimum contribution is a good starting point. It is important to remember that the cash balance plan minimum contribution is only the beginning. Once the account is funded, the employee can enjoy retirement without any interruption in his or her salary.
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The cash balance plan minimum contribution is 3% of employee income. The employer’s contribution will be determined based on the employee’s age and the company’s size.
Many companies already offer a company retirement plan that offers an employer-paid contribution of 3% to 5% of employees’ annual salaries. As long as it passes the testing requirements, cash balance plans are a great option for business owners. If you have a small business, the minimum contribution is low.
This type of plan is a tax-favored retirement plan. The IRS is likely to favor your contributions if they are in the correct tax bracket. If your employees’ earnings don’t increase significantly, the employer’s contribution can be reduced.
| Prepare for increased costs | Cash balance plans have higher fees compared to defined contribution plans. Sponsors should be ready to cover economic costs, benefit costs, administrative fees, Pension Benefit Guaranty Corporation premiums, and investment management expenses. |
| Contributions ✅ | Small businesses should ensure that the business generates enough income to support high contributions under a defined benefit plan. Skipping a contribution increases subsequent contributions and general plan costs. |
| Plan liabilities ✅ | Opportunities like small-amount bulk-sum sweeps or an ongoing lump-sum offer are effective and cost-efficient ways to help a sponsor reduce liabilities in a cash balance plan. |
| Investment strategies | A plan investment strategy should align with the plan objectives and acceptable investment returns. |
| Risk tolerance | Risks associated with a plan like equity exposure should be monitored regularly. A limit should be addressed on how much risk a plan can take and an exit strategy if circumstances go out of hand. |
Funding the Minimum Contribution
The minimum contribution in a cash balance plan is calculated on a per-capita basis. If your salary is higher, you can make a smaller contribution. The maximum contribution amount in a cash balance plan can be lower than your 401(k) plan.
A minimum contribution is important for retirement planning. The IRS allows you to withdraw money from a savings account in a cash balance plan only when you need it.
A cash balance plan’s minimum contribution is set by the sponsoring company. A cash balance plan participant must pay a minimum amount of taxes to benefit from the tax-deferral provisions. The employer is solely responsible for the investment risk.
For a small business owner, the minimum contribution will increase over time as the profits from the cash balance account increase. This is why a minimum contribution in a cash balanced plan is an important part of the overall retirement plan.
In a cash balance plan, the employer’s contributions to each employee’s account balance are typically based on a predetermined formula that includes factors such as the employee’s wage and years of service. A cash balance plan is a defined benefit pension plan that combines elements of traditional defined benefit plans with those of defined contribution plans, such as 401(k)s.
How do minimum contributions impact a cash balance plan?
Contribution levels to a cash balance plan impact in a number of ways:
- Pay credits: The pay credits in a cash balance plan formula may be based on the employee’s age, with higher pay credits for older employees. Older employees generally have a shorter time horizon until retirement, so they may need larger contributions to achieve the same retirement benefit as younger employees.
- Interest credits: The interest credits in a cash balance plan formula may be based on the employee’s age, with higher interest credits for older employees. Older employees generally have a shorter time horizon until retirement, so they may need larger contributions to achieve the same retirement benefit as younger employees.
- Maximum annual contribution limit: The maximum annual contribution limit for a cash balance plan is the lesser of (a) 100% of the employee’s salary or (b) the maximum annual contribution limit for defined contribution plans, as set by the IRS.
Overall, age may impact the contributions to a cash balance plan in a number of ways, including the pay credits, interest credits, and maximum annual contribution limit. It is crucial for employers and employees to review the terms of the plan carefully and to consult with a qualified professional to understand how age may impact the contributions to a cash balance plan.
Bottom line
As the minimum contribution in a cash balance plan is set by the employer, you will need to pay taxes on the earnings of your investments. The income tax you pay is paid after the tax-deferral period, which is why the cash balance plan minimum contribution is calculated annually by an actuary.
You must also pay the Medicare surtax, which is 3.8% of investment income. If you are a business owner, a minimum contribution in a cash balance plan is a good idea.
