Cash Balance Plans: What's Your Advantage?

Need to boost your retirement savings? A cash balance plan — generally along with a 401(k) plan — might allow you to compensate for years of underfunding your retirement.

Blending features of a traditional pension plan with the look and feel of a 401(k)/profit-sharing plan, these hybrid plans require company contributions based on a percentage of pay or a flat dollar amount. An annual interest credit set in the plan documents is credited to each participant’s balance. You must ensure contributions to your plan are invested to pursue the plan’s rate goal. When a participant terminates employment, vested account balances can be withdrawn, which may trigger taxes, or rolled over to an IRA or other employer retirement plan.

POSITIVES

For owners and higher paid employees, the biggest attraction of cash balance plans is that they allow tax-deferred contributions much higher than the limits placed on 401(k) and other defined contribution plans. You and your employees can contribute to both plans, and you do not need to include all employees in the cash balance plan. Another attractive feature is that your company may claim an above-the-line tax deduction for contributions.

For those nearing retirement, cash balance plans, unlike traditional pension plans, have accelerated vesting requirements. Participants must be 100% vested in their benefits no later than after completing three years of vesting service. No graded vesting schedule is allowed. The Pension Benefit Guaranty Corp (PBGC) protects most benefits under a cash balance plan.

NEGATIVES

These plans are subject to IRS minimum funding requirements, which may require cash funding in years your company would rather not contribute at all or as much as necessary. With an exception for small benefits, a cash balance plan must offer forms of payment other than lump sums (e.g., Qualified Joint and Survivor). Generally, the plan sponsor has to pay PBGC premiums. Because they’re subject to many of the pension plan requirements, cash balance plans are more complicated than a 401(k). Consult your financial professional.