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Cash Balance Pension Plans

Is a Cash Balance Pension Plan Right for You?

In a cash balance pension plan, an employer offers its employees an account that will reach a certain minimum balance by the employee’s retirement date. For instance, an employer might promise to give an employee an annuity worth $100,000 once he or she reaches age 65.

Many company owners like cash balance retirement plans because, when used in combination with a 401(k)/profit sharing plan, they offer much higher contribution limits than a 401(k)/ profit sharing plan alone. These contributions are tax deductible, reducing an owner or employee’s taxable income for that year dollar for dollar.

In a 401(k)/profit sharing plan alone, the maximum amount that someone under age 50 can contribute is $53,000 for 2016. But if your company adds a Cash Balance Pension plan, your maximum deductible contribution rises to a total of $356,716, although in most cases it will be a lower number than the maximum. Unlike 401(k) plans, which by law cannot favor highly compensated employees, cash balance plans allow high-earning employees to contribute more within IRS requirements. However, there are ERISA requirements to ensure the plan is not discriminatory against any subset of employees. For example, 40% of the employees must be part of the plan or 50 employees—whichever is smaller—must benefit from the plan.

In the past, cash balance pension plans were hard to use. Today’s cash balance plans have been set up to be as easy for workers to use as a 401(k). Employees could ge3t regular statements showing the cash value of their account, and, If they leave the company, the investment dollars are portable.

2016 Plan Annual Maximum Contribution Amounts

2016 Plan Annual Maximum Contribution Amounts

Employee Age

401(k) & Profit Sharing Plan

Cash Balance Plan

Total Per Year





















*(Savings maximums increase annually, but only select ages are shown)

Funding a Cash Value Plan

In a cash value plan, employers make an annual contribution for participating employees. The amount is based on a target amount of savings they have promised to each employee by retirement and the return they expect on the investments in the account. The employer deposits a “pay credit” into each participant’s account annually, as well as an “interest credit.” For the pay credit, an employer might contribute a percentage of the employee’ compensation. The interest credit is the amount of interest the employer expects to see on the investments in the account. It is tied to an index, such as the one-year Treasury bill rate.

Each year, employers’ contributions are adjusted to reflect the performance of the investments in the account, so the company stays on pace with the savings goal for that employee. If the investments hit more than a targeted rate of return, the employer must contribute less. However, if the investments reach a lower rate, the employer must contribute more. A good plan will be designed for consistent returns from year to year—with a range of 3% to 10%. That way, the employer doesn’t have to make a giant contribution if, for instance, there is bear market—or face a year where returns are very high, contributions are reduced and, as a result, tax deductions are limited.

Upon retirement an employee can opt to receive the balance of a cash balance plan in annual payments for life or in a lump sum equal to the balance. Since the plans are portable, often the employees decide to roll the lump sum payments into an IRA or if they change jobs, into another employer’s plan.

Cash balance plans are considered “hybrid” plans because they combine elements of a traditional pension plan, like the option for fixed payments, with an investment component like a defined contribution plan such as a 401(k).

How Cash Balance Plans Differ From 401(k)s

A cash balance plan is very different from a 401(k) in several ways.

The major difference is that employees know exactly how much money they’re getting upon retirement with a cash balance plan. A cash balance plan is a defined benefit plan, meaning employers agree to provide employees with a specific dollar amount when they retire. The employer shoulders the risks of the investments. Employers must offer the benefit as lifetime annuity or lump sum payment.

A 401(k) plan, in contrast, is a defined contribution plan. The payout to employees when they retire is uncertain. It depends on the amount they have contributed and how the investments in the account have performed. The employees bear the risks of the investment. Employers are not required to provide lifetime annuities.

In a cash balance plan, the investment decisions are typically made by the trustees of the plan, often along with other professional advisors. In contrast, in a 401(k) employees make their own investment choices within the universe of options offered under the plan.

Another difference is the source of the contributions. While in some 401(k) plans, employees make discretionary contributions, in a cash balance plan, that generally is not the case. The employer is the only party to contribute.

Another difference is the level of federal protection a cash balance plan is afforded. The benefits in a cash balance plan get some protection from federal insurance that comes through the Pension Benefit Guarantee Corporation (PBGC). That means if a troubled cash balance plan ends up without enough funds to pay all the beneficiaries in full, the PBGC can assume trusteeship and pay the benefits. There are limits set by law. A 401(k) plan is not protected by the PBGC.

Setting up a Cash-Balance Plan

To set up a cash balance plan properly, you will need the help of an actuary and pension expert. These plans can be complicated to set up and maintain. Usually the plans are designed so the investments produce the same rate of return as the set interest rate so the employer doesn’t have to deal with making up for any shortfalls.

If you convert your company’s 401(k) or other retirement plan to a cash balance plan, there are some important administrative requirements to follow. It is important to get professional advice so you comply with them properly.

  • You must notify employees at least 45 days in advance if, under the new plan, the rate at which they build up retirement benefits will slow significantly
  • You generally can’t reduce benefits participants have already earned
  • You can’t discriminate based on age

If you are thinking of setting up a cash balance plan, do it before the end of the year so you can take advantage of this year’s tax credits. It takes some legwork and professional advice, but the tax savings are often worth it. At 401k Strategies, we specialize in helping companies convert their existing retirement plans to new plans that offer far greater benefits for the owners and staff. The popularity of cash balance plans has grown enormously as business owners have learned the advantages of these plans.   Call 401k Strategies today to learn more.

 The information provided is for illustrative purposes only and is not intended to serve as either legal or tax advice.