We get a lot of questions regarding investment accounts for cash balance and defined benefit plans. Specifically, if you and your spouse are the only participants, should you open up an investment account for each of you?
At Emparion, we are not investment advisors or custodians. As a general rule, we don’t open up brokerage accounts for clients. But many people believe the accounts are structured similarly to a 401(k) plan. Unfortunately, this is not the case.
In this post, we’ll discuss how investment accounts work for cash balance plans and defined benefit plans. We will explain what a “pooled” account is and how they work. Let’s jump in!
401(k) Participant Accounts
When it comes to a 401(k) plan (or any other type of define contribution plan), you will generally set up a separate participant account for each plan participant. That way they can manage their own investments and track their specific investment balances.
While 401(k) plan assets could be commingled, this offers many challenges especially surrounding investment options. Because 401(k) plan assets are contributed directly to the employee, the participant should have control of the account investments. If these assets were pooled, then possibly a financial advisor or trustee would be in charge of investment decisions or might make trades at the recommendation of the plan participants.
In either case, this would be an administrative nightmare. In addition, if assets did not perform well, the plan trustee or investment advisor could face liability for poor investment returns. That’s why having individual participant accounts makes most sense and is a very common practice.
What is a Pooled Account?
Investment accounts for defined benefit plan (or cash balance plan) contributions work differently. These contributions are made to a “pooled” account. This means the contributions are made in a lump sum to one account, and individual accounts are not opened for each participant in the plan.
Unlike a 401(k) plan or an IRA, there are no individual sub-accounts for participants, meaning each employee cannot access an online account balance at any time. This pooled account is necessary because the plan considers the total funding amounts for all employees collectively.
Although the funds are not kept in separate accounts for each employee, this does not imply that they aren’t monitored at the individual level. At Emparion, we will track the individual account balances assigned to each employee and provide statements for participants. This tracking will also include information on vesting and forfeitures to ensure that all contributions are allocated correctly.
While it’s not wrong to have multiple separate investment accounts for one defined benefit plan, there would be many issues with participant accounts. We’ll discuss this shortly.
How Does a Defined Benefit Plan Work When it Comes to Investments
It is important to understand how defined benefit plans work. Defined benefit plans are designed to guarantee each participant a pay credit and an interest credit.
For example, let’s assume a specific employee was given a pay credit contribution of $100,000. You would NOT contribute this $100,000 into a separate employee account and then when the employee leaves the company, they receive the balance in the account. Again, this would be similar to a 401(k) plan.
The employee is actually entitled to the $100,000, plus an interest credit (let’s assume 5%) annually. What happens if after a year the employee leaves the company when the account balance is $150,000? Assuming they were fully vested, they would receive $105,000. This represents the pay credit plus a 5% interest credit. They would NOT receive $150,000.
The remaining $45,000 is not allocated to that employee. It merely stays in the investment account and will get reallocated to other employees in the future. Understanding this difference in how these plans work is critical.
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How Are the Funds Tracked?
Unlike individual accounts in defined contribution plans, pooled accounts consolidate funds from all participants into one collective portfolio. This structure allows the business owner or trustee to manage investments collectively for the benefit of all participants.
In a defined benefit plan, participants do not control investment decisions within the pooled account. Instead, the employer or business owner is responsible for ensuring adequate returns to meet promised benefits. This centralized approach simplifies administration while providing participants with guaranteed retirement benefits based on the plan’s formula.
Problems with Separate Accounts
Here are some of the problems with multiple investment accounts:
- Our actuary needs all the account balances as of the end of the plan year to determine actuarial funding. When there are multiple counts, sometimes clients forget to give us all accounts which results in inaccurate contribution amounts.
- If a participant was told that a contribution was made on their behalf, they would likely believe that the entire account balance is theirs. This would be especially true if the account was set up as “for the benefit of” or “FBO” with their name attached to it. This can lead to substantial confusion and even litigation.
- The more accounts that are established, the more challenging it is to track investment performance. It also can make portfolio diversification more challenging. Remember that investment returns are very important to plan funding, so the account consolidation is usually the best way to track investment returns.
Final Thoughts
Pooled investment accounts in defined benefit plans provide a unified approach to managing retirement assets. By combining contributions into a single account, these plans simplify investment oversight and administration.
In conclusion, pooled investment accounts play a vital role in ensuring defined benefit plans operate effectively. They provide professional management and shared growth opportunities while guaranteeing participant benefits. This collaborative approach ensures long-term stability and meets the plan’s funding obligations efficiently.
