Demand for cash balance plans remained strong during the pandemic. Here’s why.
What is a cash balance plan? In this type of defined benefit plan, instead of the typical monthly benefit at retirement provided by a traditional DB plan, a cash balance communicates the benefit as an account balance. It is a DB plan because the participant is always able to convert the account balance into an annuity at retirement. Otherwise, it is a typical DB plan—the account balance is guaranteed and the plan has minimum funding requirements.
A cash balance plan is also subject to the benefit and related contribution limits of a DB plan, which allows for much greater deductible contributions for employees nearing retirement age.
In 2001, there were 1,337 cash balance plans. By 2017, there were over 20,000 plans, with double-digit percentage annual growth. What are the reasons for such growth—and how have cash balance plans fared during the pandemic?
REASONS FOR GROWTH
The factors driving the growth of cash balance plans fall into several diverse categories. Let’s take a look.
Demographics. The Baby Boomers are approaching retirement age and many have not saved enough. A cash balance plan allows substantial additional savings for retirement.
Legislative. There have been several developments in this regard over the last 20 years. One of the more significant ones was the Pension Protection Act of 2006 (PPA), which included several provisions that benefited cash balance plans. The PPA:
- Allowed the benefit from a cash balance plan to be the account balance of the participant. Before PPA, there was litigation over whether the account balance had to be projected to a retirement age, converted to an annuity and then converted to a lump sum by current interest rates. Cash balance plans implemented after PPA would not have confusion about the lump sum benefit.
- Allowed expanded employer contributions to a 401(k) plan when paired with a cash balance plan for plans not covered by the Pension Benefit Guaranty Corporation.
Development of IRS pre-approved documents for cash balance plans. Just over 10 years ago, each cash balance plan was individually drafted and an IRS determination letter of approval was requested. The cost of implementation of a cash balance plan was significantly reduced with the use of IRS pre-approved documents.
Expertise. To achieve the growth described above, more firms had to develop the knowledge to implement and administer cash balance plans. Over the past 20 years, there has been significant growth in the number of firms in the cash balance marketplace, and some TPA firms have outsourced the actuarial function to an actuarial firm.
EMPLOYERS IMPLEMENTING CASH BALANCE PLANS
The majority of cash balance plans have been implemented by:
- Businesses with consistent profits
- Professional firms such as law firms, medical professionals, CPAs and financial professionals
- Businesses with no or just a few employees other than the
NEW CASH BALANCE PLANS DURING THE PANDEMIC
The reason for this article was new plan sales information from my employer. Through the end of September 2020, the number of new cash balance plans implemented by The Retirement Advantage (TRA) increased over the number of plans year-to-date in 2019. Several other firms and actuaries have described similar sales growth. Additionally, the SECURE Act, which was enacted at the end of 2019, gives employers additional time—until the due date of their tax return—to implement a cash balance plan.
What’s driving new plan sales during the pandemic? First, consider the list of businesses above that typically implement cash balance plans. Many of these businesses are in a comparable business situation as they were before the pandemic. For example, CPAs, in addition to the usual
accounting and tax return work, were also in the business of preparing PPP loan applications for their clients. So, during the pandemic, all employees continued to work. These employers applied for PPP loans and likely received them, and then they were forgiven because the employees continued to be paid.
Most of the law firms that we worked with also continued working during the pandemic and may have been in a similar position.
There were also new businesses that were good cash balance candidates. For example, doctors who met with patients over the internet were busier than ever. And many businesses in the construction industry are now busier than ever.
HOW ARE EXISTING CASH BALANCE PLANS SURVIVING THE PANDEMIC?
The CARES Act provided relief for DB plans, including cash balance plans. Specifically, under the Act, any contributions due in 2020 did not have to be contributed until Jan, 1, 2021. Also, funding percentages for 2019 could be used for 2020 with proper election with respect to lump sum distributions, freezing benefits and other issues.
We recently completed the cycle of preparing 2019 IRS Form 5500s for all plans, including cash balance plans, so we have had contact with nearly all of our cash balance clients. I have been surprised at the percentage of businesses with cash balance plans that have continued their plans and
contributions during the pandemic. Certainly, those who have experienced significant difficulties because of the pandemic would be justified in freezing or terminating their plan as a result of change in business circumstances.
CASH BALANCE PLANS ARE HERE TO STAY!
Based on the continued increase in the number of cash balance plans and the continuation of current plans, cash balance plans will continue to be a part of the retirement plan marketplace. In addition, the positive impact of the SECURE Act has yet to be measured. In addition to being able to implement a plan until the due date of the tax return, the SECURE Act also provides for a tax credit for employers that implement a plan if they never had one before.
With TPA and actuarial firms ready to assist employers in designing and implementing cash balance plans and utilizing the provisions of the SECURE Act, cash balance plan growth will continue!
Cash Balance Plans continue to be the fastest-growing segment of the retirement plans market, in part because they:
- Allow for substantially larger tax-deductible contributions versus other types of plans.
- Help business owners attract and retain top talent.
- Are both cost- and tax-efficient.
- Allow for varying contribution levels.
- Can be added to another qualified plan.
Contact your TRA Regional Sales Consultant today to learn more and get started.