Why All the Buzz Around Cash Balance Plans?

Got five minutes? The topic of this blog post is covered in our Fiduciary Five Podcast series hosted by Chuck Hammond of the 401(k) Study Group. The Fiduciary Five Podcast…your fiduciary questions, answered in about five minutes.  To listen to the related podcast, click here.

In the retirement plan space today, there is a tremendous amount of talk about Cash Balance plans. Will they work for my client’s business? Are they expensive? Is it the same thing as a defined benefit (pension) plan? What is the benefit? Are they too good to be true?

A cash balance plan may work very well for your client’s business. The plans are typically designed to maximize the benefit generated for the owners of the business. It can supplement the retirement for a certain group of employees. It could lower a business’ tax burden.  It could provide an extra benefit and be a recruiting tool for new talent and to existing employees in their company.

It is important to figure out, right up front, if a cash balance plan will work for the business. Typically, if the business is generating a lot of money to the owners, a cash balance plan is worth a look. After all, a good amount of that money is going to be taxable. Ideally, cash balance plans should be efficient in the range of 80% or better. What that means is that by design, 80% of the benefit or more should go to those key participants that they design the plan to benefit. Think of the business owners and the favored few, or key, personnel. It is also worth mentioning that we have done cash balance plans with a lower efficiency to meet a specific need for a business owner, so 80% is a general guideline rather than a hard and fast rule.

The plan sponsor will have a fiduciary obligation to design and run the plan in compliance with all governing rules.  The plan should be designed to exist in perpetuity, so if they are going down this road, design the plan with a funding level that they can afford year after year.  In short, if cash flows are rich and consistent year over year, they are most likely a viable candidate, but if it is inconsistent, where they are flush in only occasional years, they may not be as viable.  Setting up a plan just to shelter away money for a single good year could bring unwanted attention from certain governing bodies.    That being said, let’s assume that they have that extra cash flow available each year. By design, what they could put in to a cash balance plan each year and what they can afford year over year may be totally different. It is important to make sure that when you are putting together the illustrations for the plan, you have had that discussion with your plan sponsor and provider.

Practically speaking, a cash balance plan allows the employer to combine participants in to certain groups, or to go so far as to make every participant in the plan, their own group.  This allows them complete flexibility in who the plan will benefit and by how much.  Age also plays a role in the design of these plans.  The working years’ horizon plays a large role in the maximum benefit allowed to the main beneficiary.  Cash balance plan design can be a challenge for young business owners, which brings us to the next critical point. Work with a professional!

It is extremely important to work with someone who understands the right and wrong way to design the plan as well as the nuances and mechanics of cash balance plans in particular.  This isn’t every investment professional, or even necessarily every 401(k) professional.  Cash balance plans are complex and require care when deciding on implementing one.  There are certain questions that need to be asked and answered in the initial stages of design that will save a lot of headaches down the road and make the plan run smoothly or more pointedly, ensuring that the plan doesn’t have an unintended negative result.

Finally, while cash balance plans can be great plans, they shouldn’t be thought of as a replacement for their 401(k) plan. This plan can be a great compliment to their existing 401(k) plan.  That long discussion is for another blog post, but in short, when designed properly these plans will work in unison and be tested together for maximum efficiency and benefit to both the business and to the employees.

Cash Balance plans are available to any business and may be worth a look.  If you are not using them to grow your practice, Cash Balance is worth considering.

Nathan Paris is an Institutional Retirement Consultant for Unified Trust covering Kentucky and the Texas/South Central U.S.  For more information on Cash Balance plans, or on Unified Trust and how we can help you, please contact us at advisor services at 866-296-6682 and see how we can help you!

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