Cash balance plans are pension plans that are designed to provide retirement income for employees. There has been some controversy surrounding cash balance plans, with some critics arguing that these plans may disproportionately benefit younger employees at the expense of older employees.
One of the main reasons for this concern is that cash balance plans typically provide a guaranteed benefit in the form of an annual contribution to the employee’s plan account, rather than a fixed monthly pension payment in retirement. This contribution is typically based on a percentage of the employee’s salary, which may be more beneficial for younger employees who have a longer time horizon to accrue and grow their savings. Older employees, on the other hand, may receive a smaller benefit due to the shorter time they have to accrue savings.
It is important to note that cash balance plans are subject to certain legal requirements, including nondiscrimination testing, which are designed to ensure that the plans do not disproportionately benefit younger employees. However, some critics argue that these requirements may not go far enough to address concerns about potential disparities in benefits between younger and older employees.
Overall, it is important to carefully consider the potential advantages and disadvantages of a cash balance plan before deciding whether it is the right choice for you. It may be helpful to speak with a financial advisor or a retirement specialist to get guidance on the potential benefits and risks of this type of plan.
Cash balance plan contribution limits
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. In a cash balance plan, the employer contributes a fixed amount, or “cash balance,” to an account for each employee, which earns a guaranteed rate of return. The employee’s account balance is portable and can be taken with them if they leave the company.
Cash balance plans are subject to contribution limits set by the Internal Revenue Service (IRS) to ensure that the benefits provided under the plan are reasonable and non-discriminatory. The contribution limits for cash balance plans are determined based on several factors, including the age of the employee, the salary of the employee, and the terms of the plan.
Here are some critical contribution limits for cash balance plans:
- 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. For tax year 2021, the maximum annual contribution limit for defined contribution plans is $58,000 for employees under age 50 and $64,500 for employees age 50 and over.
- Age 50 catch-up contributions: Employees age 50 and over are allowed to make additional “catch-up” contributions to their cash balance plan account. For tax year 2021, the catch-up contribution limit is $6,500.
- Annual benefit limit: The annual benefit limit is the maximum amount that an employee can accrue in benefits under the cash balance plan each year. For tax year 2021, the annual benefit limit is less than (a) $230,000 or (b) 100% of the employee’s average wage for the highest three consecutive years.
It is important to note that these contribution limits are subject to change yearly based on inflation adjustments. Employers and employees should carefully review the terms of the cash balance plan and consult with a qualified
How do the plans work?
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. There are several benefits to cash balance plans for both employers and employees:
- Predictable cost: For employers, one of the main benefits of a plan is that it provides a predictable cost for funding retirement benefits. The employer must contribute a fixed amount to each employee’s account, making it easier to budget and manage the plan’s costs.
- Portability: Cash balance plans offer portability, which means that employees can take their account balance with them if they leave the company. This is in contrast to traditional defined benefit plans, which are typically not portable and are forfeited if the employee leaves the business before retirement.
- Higher potential return: For employees, one of the main benefits of a cash balance plan is the potential for a higher return on their contributions compared to traditional defined contribution plans, such as 401(k)s. The guaranteed rate of return on the account balance in a cash balance plan is typically higher than the returns employees can achieve on their own in a defined contribution plan.
- Tax benefits: Cash balance plans also offer tax benefits for both employers and employees. Contributions to a cash balance plan are tax-deductible for the employer and made on a pre-tax basis for the employee. Plus, the investment earnings on the account balance are tax-deferred, allowing the employee to save on taxes until retirement.
- Customization: Cash balance plans can be customized to fit the needs of the employer and the employees. The employer can choose the contribution rate and the formula for calculating the guaranteed rate of return, and the employees can choose how to allocate their contributions among investment options.
Cash balance plans offer a combination of security, portability, and potential for higher returns, making them an attractive retirement benefit for employers and employees.