Wednesday, September 10, 2014

Cash Balance Plans - Simplified

So, what's all of this noise about this "new" kind of Retirement Plan that's all the rave, called a Cash Balance Plan and how do I 'Cash In'? 

The following information is meant to be informative, while not necessarily all encompassing.

What is a Cash Balance Pension Plan?
A cash balance plan is a type of Defined Benefit (DB) plan that looks and feels like a Defined Contribution Plan (DC) such as a 401(k) or Profit Sharing Plan.  However, just because it looks like a DC plan doesn't mean that it is one, in fact it has more similarities to its' brother the traditional DB pension than it does to its' cousin the 401(k) Plan.  Like traditional DB plans, Cash Balance plans are backwards-looking in that that they guarantee a determinable benefit to eligible participants and use annual contributions plus investment earnings to get to that end benefit at some later date. 

What do you mean it looks/feels like a DC plan?
The allocation formula and the promised benefit are stated as a hypothetical account balance.  They are hypothetical because they do not reflect the actual contributions to and gains/loses allocatable to the account.  Rather they are attempting to give the participant a fair estimate of what their "balance" is in the plan.  Realistically, the benefit they receive is the predetermined balance defined by the plan that won't be achieved until that participant reaches retirement age.

How does it work?
Like all DB plans, the investments are pooled and set up in a trust, allowing for economies of scale to be gained on investment expenses and eliminated the need for "daily valued" record keeping.  Also like other DB plans, these plans are tax-qualified under the IRC and governed under ERISA .  They are required to have fiduciaries in charge, namely the Plan Sponsor, Trustee and Plan Administrator and require the use of an Actuary.  Many of these functions can be outsourced as well.

In a typical cash balance plan, each participant's hypothetical account is comprised of two parts; the pay credit and the interest credit.  The pay credit is typically a fixed amount (such as $25k/year) or a fixed percentage of compensation, like 5% for example.  The interest credit is either a fixed or variable rate linked to an index, such as the 30-Year Treasury. 

These contributions are made annually and invested.  The earnings on investments ought to be engineered to achieve the Interest Credit as a return, no more no less.  The goal most often associated with Cash Balance plans is to maximize tax deductible contributions for the owners, key personnel and highly paid group.  Unlike DC plans, however, contribution amounts from year to year can be theoretically unlimited since the contributions over time must equal what is needed to finance (fund) the promised benefit.  This allows contributions to often go well north of the DC Plan 415 limit of $52,000.  Often these contribution amounts could near $200,000/year for an individual person.

Who would use a Cash Balance Plan and why?
Cash Balance plans are popular among companies that are very rich in revenue while maintaining a fairly low number of employees.  Employers such as law firms, professional groups, CPA firms and medical practices come to mind.  These business' often have strong cash flows historically and prospectively, large budgets, relatively low numbers of employees where most of them are making substantial wages (north of $125k for example), have multiple owners or partners, max out on DC contributions and have mostly an older highly paid workforce.

What about costs and other barriers?
The main costs associated with Cash Balance plans are the contributions themselves since they tend to be much higher and are employer funded plans.  Administrative costs are typically not more burdensome than other plan administrative expenses and sometimes less.  Investment expenses are typically low due to the need to pool investments in a trust and the conservative nature of the investing.  Cash Balance plans can be for any type of employer, however, note that they must be contributed to for a minimum of three years.

Hopefully, this was helpful in explaining some of the main points about Cash Balance plans.  Obviously, this was an overview.  If anyone has questions, they can comment on this post or reach me directly at


Brokerage Windows in 401k Plans: Get Off the Beach!!!

Linked below is a really nice Op-Ed on Brokerage Accounts as pertains to using in 401(k) Plans. Really like the analogy regarding foolish people on a beach during Hurricane Sandy.  The author does a nice job of explaining the issue in a non-technical way.  Enjoy.