Cash Balance Plan Providers, Rules & Administration Services
Many business owners and partners of firms are looking for larger tax deductions and accelerated retirement savings. Cash balance plans can help provide above-the-line deductions that directly reduce ordinary income dollar for dollar.
What is a cash balance plan?
A cash balance plan is an IRS-qualified retirement plan known as a “hybrid” plan. Each employee, or participant, receives a contribution to an account and it grows in two ways: by an employer contribution and by an interest credit, which is guaranteed rather than dependent on the plan’s investment performance.
The annual interest credit is guaranteed and is not dependent on the plan’s investment performance.The interest credit is usually a fixed percent, such as 5%. Plan assets are pooled and invested by the trustee or investment manager. If the plan’s investment earnings exceed the guaranteed rate, the excess will be used to reduce future employer contributions. This will not affect the amount that is credited to the participant’s account. Conversely, if the plan’s investment earnings are less than the guaranteed rate, then future employer contributions will be increased. This makeup is typically spread out over seven years. A wide range of investment vehicles can be used by the plan sponsor to achieve the interest crediting rate.
What are the benefits of a cash balance plan?
Cash balance contributions reduce both taxable income and adjusted gross income, so high income earners may move into a lower tax bracket. All of the following taxes may be reduced or eliminated by contributing to a cash balance plan:
- Investment Tax: An additional 3.8% tax on unearned net income is imposed on individual earning over $200,000 (or $250,000 for married couples). The surtax is in addition to the capital gains and dividend tax of 15%, 20% for high earners.
- Top Marginal Income: The top marginal tax rate is 37% for individuals earning over $609,350 (or $731,200 for married couples). A Cash Balance contribution reducing income for a married couple below $731,200 will result in tax savings plus a reduction in the marginal income tax rate!
- Medicare Tax: There is an additional 0.9% Medicare payroll tax on income above $200,000 (or $250,000 for married couples).
- Phase-Out of Tax Deductions: The ability to itemize certain deductions is phased out for individuals earning over $200,000 for individuals making more than $250,000 (or $300,000 for married couples)
Cash balance plans ultimately help employers and participants save more money, with significantly higher, tax-deferred contribution limits and major tax deductions.
Download the tax advantages of cash balance plans now.
Who may establish a cash balance plan?
Ideal cash balance candidates include:
- Principals seeking a tax deduction of more than $50,000 or making more than $250,000 per year
- Highly profitable companies of all types and sizes
- Successful family businesses and closely held businesses
- CPA and law firms, medical groups and professional firms
- Older owners who need to squeeze 20 years of retirement saving into 10
Who may participate in a cash balance plan?
Both employers and employees may participate in this plan. Each participant may have a different amount contributed for them. After designing more than 1,000 cash balance plans, we have found that the following are typically good candidates:
- Partners or owners that desire to contribute more than $50,000 a year to their retirement accounts
- Many professionals and entrepreneurs neglect their personal retirement savings while they’re building their practice or their company. They often have a need to catch up on years of retirement savings. Adding a cash balance plan allows them to rapidly accelerate savings with pre-tax contributions as high as $240,000, depending on their age.
- Companies already contributing 3–4 percent to employees, or at least that are willing to do so. While cash balance plans are often established for the benefit of key executives and other highly compensated employees, other employees benefit as well. The plan normally provides a minimum contribution between 5 and 7.5 percent of pay for staff in the cash balance plan or a separate profit-sharing 401(k).
- Companies that have demonstrated consistent profit patterns. Because a cash balance plan is a pension plan with required annual contributions, consistent cash flow and profit are very important.
- Partners or owners over 40 years of age who desire to “catch up” or accelerate their pension savings. Maximum amounts allowed in cash balance plans are age-dependent. The older the participant, the faster he or she can accelerate his or her savings.
How do I start a cash balance plan?
- Adopt a written plan, called the plan document, which outlines its day-to-day operations.
- Identify a plan provider and/or trust for the plan’s assets and investments.
- Select a recordkeeper or recordkeeping system to track contributions, earnings and losses, and distributions. This person or entity will also help prepare the annual return, which must be filed with the federal government.
- Select a third party administrator to maintain the plan document, fulfill daily tasks and ensure compliance with federal regulations. Your financial advisor may choose a third-party administrator and/or recordkeeper on your behalf.
- Provide eligible employees, or plan participants, with a summary plan document (SPD), which is the document that outlines who can participate and how the plan works.
If the plan allocates responsibilities for performing administrative functions to other parties, such allocation must identify who is responsible for ensuring compliance with the requirements of the tax code, including compliance requirements for loans and distributions.
In the case of funding through multiple financial institutions, the employer may adopt a single written plan to coordinate administration among the financial institutions, rather than having a separate document for each issuer.
Cash Balance 101
In a Cash Balance Plan each participant has an account. The account grows annually in two ways: first, a contribution and second, an interest credit, which is guaranteed rather than being dependent on the plan’s investment performance.
Many owners and partners are looking for larger tax deductions and accelerated retirement savings. Cash Balance Plans may be the perfect TPA solutions for them. The 2006 Pension Protection Act (PPA) and the Cash Balance regulations issued in 2010 and 2014 have made these plans even more flexible and easier to administer, making them increasingly popular choice for successful business owners.
What makes a good candidate?
Many partners and professionals find Cash Balance an excellent way to increase contributions to their retirement accounts. After designing over 1,000 Cash Balance Plans, we have found that the following are typically good candidates:
- Partners or owners who desire to contribute more than $50,000 a year to their retirement accounts.
Many professionals and entrepreneurs neglect their personal retirement savings while they’re building their practice or their company. They often have a need to catch up on years of retirement savings. Adding a Cash Balance Plan allows them to rapidly accelerate savings with pre-tax contributions as high as $100,000 to $240,000, depending on their age.
- Companies already contributing 3-4% to employees, or at least willing to do so.
While Cash Balance Plans are often established for the benefit of key executives and other highly compensated employees, other employees benefit as well. 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.
- Companies that have demonstrated consistent profit patterns.
Because a Cash Balance Plan is a pension plan with required annual contributions, consistent cash flow and profit is very important.
- Partners or owners over 40 years of age who desire to “catch up” or accelerate their pension savings.
Maximum amounts allowed in Cash Balance Plans are age-dependent. The older the participant, the faster they can accelerate their savings.
- Partners or owners who desire to contribute more than $50,000 a year to their retirement accounts.
How do deductions & allocations work for partnerships?
Tax deductions for contributions made on behalf of non-partner employees are taken on the partnership tax return. Partners and owners take the tax deductions made on their behalf on their personal or corporate tax returns.
However, to be sure that the amount deducted for tax purposes by a partner as shown on Schedule K-1 is the same as the amount contributed on behalf of the partner, the partnership’s agreement must permit this method of allocation. Most partnerships that adopt Cash Balance plans do not want the partners’ contributions allocated like most other firm expenses, in proportion to ownership. Either the partnership agreement or internal policy should assure that each partner is allocated an appropriate share of the plan’s cost.
Are Cash Balance Plans protected from creditors?
Yes, Cash Balance plans are IRS-qualified retirement plans, and all qualified plan assets are protected from creditors in the event of bankruptcy. The anti-alienation provision of ERISA states that “each pension plan shall provide that benefits provided under the plan may not be assigned or alienated.” This means that the assets in a qualified plan are not available to creditors.
Since professionals and business owners often consider asset protection a premium it is very advantageous to accrue retirement savings in an asset-protected vehicle, like a qualified plan. These plans provide a means for business owners and partners to move assets from their businesses to a pension plan. Once in the qualified plan, these assets are then protected from creditors as a “nest egg” for retirement or to pass on to heirs.
Can Cash Balance Plans be offered with other plans?
Yes, an employer can offer a combination of qualified retirement plans in order to produce a larger contribution amount. Just as a Profit Sharing feature can be added to a 401(k) plan, an employer can add a Cash Balance Plan as well. In fact, a 401(k) plan in combination with a Cash Balance Plan can be the ideal plan-design for many companies and partnerships.
How does a plan work?
A Cash Balance plan is a defined benefit plan that specifies both the contribution to be credited to each participant and the investment earnings to be credited based on those contributions. Each participant has an account that resembles those in a 401(k) or profit sharing plan. These accounts are maintained by the plan actuary, who generates annual participant statements.
Participant accounts grow annually in two ways:
- The company contribution – a percentage of pay or a flat dollar amount – is determined by a formula specified in the plan document, and;
- An annual interest credit. The rate of return is guaranteed and is independent of the plan’s investment performance. That rate changes each year but usually is equal to the yield on 30-year Treasury bonds, the interest credit is usually a fixed percent, such as 5%.
When participants terminate employment, they are eligible to receive the vested portion of their account balances.
Is this a qualified plan?
Yes, a Cash Balance plan is an IRS-qualified plan, and all contributions to qualified plans are tax-deductible expenses. Like all qualified retirement plans, assets are protected from creditors. The nation’s first Cash Balance plan was introduced of Bank of America in 1985 and the Pension Protection Act (PPA) of 2006 affirmed the legality of Cash Balance plans and made the plans easier to administer. New IRS Cash Balance regulations in 2010 and 2014 expanded investment options, minimizing many funding issues and making the plans even more appealing to business owners and their employees.
Must everyone participate equally in the Cash Balance Plan?
No. Each participant can have a different contribution amount. The amount can be a percentage of pay or a flat dollar amount.
Tax Contributions/Tax Advantages
Can plan contributions change?
Profit Sharing Plans allow contributions to vary from year to year depending on profitability, but Cash Balance Plans must be amended in order to change contribution levels.
Employers can designate different contribution amounts for various participants, but there is a restriction on the frequency of amendments unless a valid economic reason exists. For example, if a firm’s profits are not expected to support its Cash Balance Plan contribution, then the plan can be amended. Any reductions must be made before any employee works 1,000 hours during a plan year. For increases, the plan must be amended within two and a half months following the end of a plan year.
In addition, a Cash Balance Plan can also be frozen or terminated before an employee works 1,000 hours during a plan year.
How much can I contribute?
Cash Balance contributions are age-dependent. The older the participant, the higher the amount is. The reason for this difference is that an older person has fewer years to save toward the approximate $2.6 million lump sum that is allowed in a Cash Balance Plan.
Subject to IRS limits, the actual contribution is determined by a formula specified in the plan document. It can be either a percentage of pay or a flat dollar amount.
What are the tax advantages?
Tax deductions are hard to come by, especially those that directly reduce ordinary income dollar for dollar.
Contributions to Cash Balance Plans have the same tax effect as a deduction that reduces ordinary income dollar for dollar!
With combined Federal and State income tax rates as high as 45%, the tax savings from the contributions and the subsequent earnings on these contributions can be very significant.
For example, one single contribution of $130,000 earning 5% a year for 30 years, would be worth $561,852 at the end of 30 years. However, if the $130,000 had been taxed in the year contributed so that an “after tax” amount was invested, and if subsequent earnings on this contribution had also been taxed in each year (assuming the highest tax rates indicated above), then at the end of 30 years the total value would be only $162,937; 29% of the amount calculated above!
Cash Balance Plans are part of a group of plans called “qualified plans,” indicating their tax-favored status with the IRS. Tax advisors generally agree that these plans should be funded to their maximum before other tax-efficient strategies are explored.
In summary, contributing to a Cash Balance Plan can provide tremendous tax benefits. These benefits apply to both the amount contributed and the subsequent earnings on those contributions. Furthermore, the investment earnings on the contribution will compound, enabling it to grow to a very significant amount.
Demand Stays Strong for Cash Balance Plans Webinar
September 27, 2023
Howard Rosenfeld – MAAA, MSPA | Actuary – Cash Balance Specialist
To view this presentation, click here or on the below cover slide.