What are Cash Balance Plans

What are Cash Balance Plans? 

Cash Balance Plans (CBPs) are tax-advantaged retirement vehicles with features like a traditional defined benefit pension plan, but the look and feel of a profit-sharing plan. They provide participants with a set percentage of their annual compensation plus interest. These plans do not have contribution limits like 401(k)s, because they are funded by the employer to fulfill a particular account balance (at the employee’s chosen retirement date). The advantage of such plans is that the contribution limitations increase with age. Small business owners can often contribute over $400k and receive a business tax deduction for the contribution.1.

 

Terms to know: 

  • Defined Benefit Plan – A company pension plan in which an employee’s pension payments are calculated according to length of service and the salary earned at the time of retirement.
  • Defined Contribution Plan: A type of retirement plan in which the employer, employee or both make contributions regularly. In defined contribution plans, future benefits fluctuate based on investment earnings.

 

Cash Balance Plans differ from traditional defined benefit plans, which compute benefits based on salary history and tenure. In Cash Balance Plans, benefits are specified as a clear account balance, simplifying the understanding and management of retirement benefits for employees.

Cash Balance Plans also have higher annual contribution limits than 401(k) plans, especially if they incorporate profit sharing. They can enable company owners to accelerate their retirement savings and realize significant annual tax deductions. 2.

For example, in 2024, the yearly maximum contribution for a 401(k) profit sharing plan is $69,000 ($76,500 for those 50 and over), but the maximum contribution for a Cash Balance Plan is up to $409,000. The chart below displays the annual maximum Cash Balance Plan contributions depending on age in 2024.

Cash Balance - 2024 Retirement Plan Contribution Chart

How Cash Balance Plans Work:

Each participant has their own account in a Cash Balance Plan. The account grows annually in two ways: 3.

  1. Through employer contributions
  2. By guaranteed interest credits

For example:

  • An employee on a cash balance pension plan may receive a guarantee of 5% of their income plus 5% interest credit.
  • If they earn $100,000 per year, they will receive a $5,000 pay credit plus 5% interest on the account amount.
  • As the number of years with the employer increases, the account balance grows to meet the company’s guaranteed amount.
  • At retirement, the employee can select between a lump sum or a monthly annuity payment.

Who Benefits the Most from Cash Balance Plans?

  • Privately held and family businesses and their owners
  • Professionals, including executives, partners, physicians, and/or attorneys
  • People who want to contribute more to their retirement accounts: Many professionals and entrepreneurs overlook their own retirement funds while developing their practice or business. They often catch up on years of retirement savings. Adding a Cash Balance Plan allows individuals to accelerate their savings.
  • People age 40 and above who want to “catch up” on their retirement accounts: Age determines the maximum amounts allowed with Cash Balance Plans. Participants can accelerate their savings at a faster rate the older they are.
  • Companies that have demonstrated consistent profit patterns: A Cash Balance Plan is a pension plan that requires annual contributions; therefore, consistent cash flow and profit are vital.
  • Companies that already contribute 3–4% to employees or are at least willing to do so: While Cash Balance Plans are often established for key executives and other highly compensated employees, other employees benefit too. The plan normally provides a minimum contribution between 5% and 7.5% of pay for staff in the Cash Balance Plan or a separate Profit Sharing 401(k) plan.

Cash Balance Plan Tax Advantages

Tax Advantages of Cash Balance Plans:

Cash Balance Plans are particularly attractive for their tax benefits, outlined as follows: 4.

  • Higher Contribution Limits: The contribution limits for Cash Balance Plans far exceed those of standard 401(k) plans. For example, while 401(k) contributions are capped at a specific amount annually for those under 50, Cash Balance Plans can allow an individual to contribute significantly more, depending on age and salary. This not only facilitates a rapid increase in retirement savings but also offers substantial reductions in taxable income.
  • Tax-Deferred Growth: Investments in Cash Balance Plans benefit from tax-deferred growth, meaning the funds within the plan are not subject to taxes until they are withdrawn during retirement. This allows the investments to compound without the immediate tax burden, potentially enhancing the growth of the retirement fund.
  • Tax Deductions for Employers: For business owners, contributions to Cash Balance Plans are deductible as business expenses. This deduction can markedly decrease the taxable income of the business while providing a robust employee benefit that includes the business owners if they participate in the plan.

Why Sign Up for a Cash Balance Plan? 

  • Attract and Retain Talent: In a competitive employment landscape, a Cash Balance Plan can significantly enhance a company’s appeal to highly skilled professionals by offering a superior potential retirement benefit compared to standard 401(k) plans.
  • Accelerate Retirement Savings: Cash Balance Plans are particularly valuable for individuals who begin saving for retirement later in their career or who need to catch up. The higher contribution limits allow these individuals to consolidate substantial retirement funds swiftly.
  • Flexible Planning: Unlike traditional defined benefit plans, Cash Balance Plans offer portability; if employees leave their current employer, they can typically roll over their accumulated balance into an IRA (individual retirement account) or a new employer’s plan, retaining control over their retirement savings.
  • Implementing a Cash Balance Plan: The adoption of a Cash Balance Plan demands strategic planning and expert consultation to ensure compliance with IRS and ERISA standards, which involves intricate calculations and detailed record-keeping. Prospective adopters must also consider the administrative and actuarial costs associated with setting up and maintaining such a plan.

2024 - Annual Contribution by Qualified Plan Type

This chart is an example and is intended for illustrative purposes only.

The Pros: 

  • Lump sum payouts: A cash balance pension can pay out in a lump sum. This can benefit someone who still has time to invest or wants to place the capital in a traditional preservation instrument like government bonds or money market funds. 
  • Rollover: You can roll a lump sum payout into an IRA or another pension plan. 
  • Tax-deferred: Contributions are tax-deferred. This means you don’t pay taxes on your distributions until you make withdrawals or take a lump sum payment. If you’re in a higher tax bracket when you’re contributing than when you make withdrawals, you pay less in income tax. 
  • No contribution limit: The annual limit for a Cash Balance pension depends on how much you make, how old you are, and the target date and balance of the fund. IRAs and 401(k)s have limits. 

The Cons: 

  • Taxable distributions: While the tax-deferred treatment is a benefit, you will have to pay taxes when you withdraw money. 
  • No employee contributions: Only the employer contributes, so you can’t add capital from your wages. 
  • The cost to maintain: The costs to maintain the plans are higher because an actuary is needed. 5.

What Happens to my Cash Balance Pension if I Quit? 

Your cash balance pension is portable, so you can take the vested portion with you when you quit and roll it into another retirement account. 

The Takeaway: 

As a strategic financial tool, the Cash Balance Plan offers distinct advantages for achieving tax-efficient wealth accumulation, particularly suited to high earners aiming to maximize their retirement reserves and minimize current tax liabilities. Combining features of both pension plan types, it supports significant contribution limits, tax-deferred investment growth, and substantial tax deductions. For businesses, it serves as an attractive benefit for recruitment and retention, while offering owners and employees alike a route to enhanced financial security in retirement.

Consulting with financial professionals is crucial for anyone considering integrating a Cash Balance Plan into their financial strategy. With proper planning and implementation, it can become a pivotal element of a secure and prosperous retirement plan.


Want to talk about it?

If you have any questions on Cash Balance Plans or other retirement plans, call us at 781-235-4426 or visit www.assetstrategy.com/contact.

Or schedule a meeting with one of our Advisors by clicking HERE for a 15-minute discovery call!

 


 

 

This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice.

Please consult the appropriate professional regarding your individual circumstance.

Because investor situations and objectives vary this information is not intended to indicate that an investment is appropriate for or is being recommended to any individual investor.

There are retirement account risks that could diminish investor returns, such as, but not limited to: low interest rates, market volatility, withdrawal timing and sequence of returns risk, government policy uncertainty and increased longevity. Prospective investors should perform their own due diligence carefully and review the “Risk Factors” section of any prospectus, private placement memorandum or offering circular before considering any investment.

Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.

Advisory services offered through Asset Strategy Advisors, LLC (ASA). Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Insurance offered through Asset Strategy Financial Group, Inc. (ASFG). ASFG and ASA are independent of CIS.

 

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