Cash balance plans have become a retirement savings option for employers and employees. These hybrid retirement plans combine elements of both defined benefit and defined contribution plans, providing participants with a guaranteed interest credit on their account balance.
A key aspect of cash balance plans is understanding who contributes. In this article, we will explore the roles and responsibilities of various stakeholders involved in contributing to a cash balance plan.
Who contributes to a cash balance plan?
The employer is responsible for making contributions to a cash balance plan. The company has an ongoing funding requirement requires an annual contribution until the plan is terminated. Upon termination, employee funds are rolled over into individual IRAs.
Many people establish these plans assuming that there can be employee deferrals. But this is not the case.
Employers play a significant role in funding a cash balance plan. They are responsible for making contributions on behalf of their employees. The contribution amount is determined based on a specified formula outlined in the plan document.
The formula may involve a percentage of the participant’s compensation, often expressed as a flat dollar amount or a percentage of salary. Employers must make the required contributions to ensure the plan remains properly funded.
Cash balance plans give participants a guaranteed interest credit on their account balance. These interest credits are determined by the plan’s design and are typically expressed as a fixed percentage or tied to an external benchmark such as the Treasury rate. The interest credits serve as a way to grow the participant’s account balance over time, in addition to employer contributions. The responsibility for providing these interest credits rests with the employer or the plan administrator.
Actuaries are crucial in cash balance plans by determining employer contribution amounts and calculating annual funding obligations. Actuaries use various assumptions, such as interest rate expectations, salary growth rates, and mortality rates, to project the future benefit obligations of the plan. These calculations help ensure the plan remains adequately funded to meet the promised benefits. The actuarial calculations are essential in determining the contribution amounts that employers need to make.
The plan sponsor, typically the employer, is financially responsible for funding the cash balance plan. This responsibility includes making timely contributions to the plan, ensuring compliance with regulatory requirements, and managing the plan’s assets and liabilities. The plan sponsor must allocate the necessary funds to meet the annual contribution obligations and maintain the plan’s financial stability.
Regulatory Guidelines and Compliance
Cash balance plans are subject to various regulatory guidelines and compliance requirements. Employers must adhere to these guidelines to maintain the plan’s tax-qualified status and ensure compliance with legal and reporting obligations. Compliance includes:
- Meeting minimum funding requirements.
- Filing annual reports with the Internal Revenue Service (IRS).
- Providing plan information to participants.
Employers must stay informed about regulatory changes and adjust their contributions accordingly to remain compliant.
Third-Party Administrators and Advisors
Many employers engage third-party administrators (TPAs) and advisors to assist with administrating and managing their cash balance plans. TPAs provide expertise in plan design, contribution calculations, regulatory compliance, and participant communication.
They work closely with the plan sponsor to ensure accurate and timely contributions and handle administrative tasks associated with the plan. Advisors, such as financial advisors or consultants, can guide plan design, investment options, and overall plan management.
How is a cash balance plan funded?
A cash balance plan is primarily funded through employer contributions. However, it’s important to note that the funding mechanism of a cash balance plan differs from that of a traditional defined contribution plan. In a cash balance plan, the employer contributes a predetermined amount or a percentage of the participant’s salary to each participant’s individual account, similar to a defined contribution plan. However, the employer also guarantees a specified interest credit on the participant’s account balance, which is more akin to a defined benefit plan.
Here’s a breakdown of how a cash balance plan is funded:
- Employer Contributions: The employer is responsible for making contributions to the cash balance plan on behalf of eligible employees. The contribution amount is determined based on a formula outlined in the plan document. The formula typically specifies a fixed dollar amount or a percentage of the participant’s compensation, such as salary or years of service. The contributions can be made annually or at regular intervals as defined in the plan.
- Interest Credits: One unique feature of cash balance plans is the guarantee of interest credits on participants’ account balances. The interest credits serve as a means to grow the account balances over time, similar to the interest earned on a savings account. The interest credit rate is determined by the plan’s design and can be a fixed rate or tied to an external benchmark, such as the Treasury rate. The employer is responsible for providing these interest credits.
- Actuarial Calculations: Actuaries play a crucial role in determining the funding requirements of a cash balance plan. They use various assumptions, including interest rate expectations, salary growth rates, and mortality rates, to project the future benefit obligations of the plan. These calculations help ensure that the plan remains adequately funded to meet the promised benefits. Actuarial calculations also consider the contribution amounts necessary to cover both the annual employer contributions and the guaranteed interest credits.
- Investment Returns: While the interest credits guarantee a minimum growth rate for participants’ account balances, the actual investment returns on the plan’s assets can exceed the guaranteed interest credits. The employer is typically responsible for managing the plan’s investments, and the returns generated contribute to the overall funding of the plan. However, it’s important to note that any investment gains or losses do not directly impact participants’ account balances, as the interest credits provide the minimum growth guarantee.
- Compliance with Funding Requirements: Cash balance plans, like other retirement plans, must comply with minimum funding requirements set by regulatory bodies. These requirements ensure that the plan remains adequately funded to meet the promised benefits. Employers are responsible for monitoring the plan’s funding status and making contributions that meet or exceed the minimum funding requirements. Failure to comply with these requirements can result in penalties or potential plan disqualification.
It’s important to consult with plan administrators, actuaries, and legal and financial professionals to ensure proper funding and compliance with regulatory guidelines when establishing and managing a cash balance plan. These experts can provide guidance on contribution calculations, plan design, regulatory compliance, and investment strategies to maximize the benefits provided by the plan and meet the needs of both employers and participants.
Contributions to a cash balance plan involve multiple stakeholders and responsibilities. Employers are primarily responsible for funding the plan and making contributions based on the plan’s formula.