Cash Balance Plan Investment Options: 5 ‘Pitfalls’ to Avoid

In the United States, a cash balance plan allows you to invest up to $100,000 pre-tax. However, there are limitations. You cannot choose between a conservative and aggressive investment strategy, and you can only contribute up to the maximum lifetime cap.

In addition, the amount you can contribute is limited. A cash balance plan is usually used in conjunction with a 401(k) Profit Sharing Plan. By contributing to both plans, you’ll have greater funding flexibility, and your employer will have less investment risk.

One of the biggest differences between cash balance plans and 401(k) plans is that the plan does not allow employees to choose what investments they make. Instead, the employees can invest their money in just about any type of investment, although most businesses invest in mutual funds, CDs, and bonds.

How to invest assets in a cash balance plan

They are similar to 401(k) plans, except that they do not give employees the freedom to decide what to invest their money in. Moreover, the accounts are held in a pooled account. Many business owners mistakenly believe that a third-party administrator manages the plan, but this is not the case.

As far as returns go, cash balance plans allow employees to invest in just about any type of investment, but most of them choose to invest in stocks, bonds, and mutual funds. These are similar to 401(k) plans, except that employees have no self-direction ability.

Because the accounts are pooled, a third-party administrator manages the entire plan for them. However, these investors do not have access to the funds themselves and have no control over the investments.

As a general rule, employees who contribute to a Cash Balance plan have access to a diversified portfolio of investments. Most plans invest in a combination of CDs, bonds, and mutual funds.

Conservative asset returns

For the most part, these plans are similar to 401(k) plans, with the main difference being that they do not give employees the ability to make investment decisions. Further, cash balance plans do not have self-direction, but instead pool assets into a pooled account.

Cash balance plans have a unique goal: to reduce taxable income, close-held professional firms want to maintain a level annual contribution to their plans. In addition, these firms appreciate a predictable annual funding schedule that helps them stay well-funded.

They want to maintain a level of funding for their plans from 100% to 110%. So they need to find a balance between conservative and aggressive funds to invest their money. But it’s not just the risk of losing the money that is most important.

Because of the volatility of cash balance plans, they are not suitable for everyone. Some people prefer a higher risk-reward ratio when investing their money in these types of plans. Nonetheless, they are not suitable for all investors.

Asset allocations

Small and mid-sized firms often fall in the risk-averse category and target stable payments. Suppose the plan’s investment portfolio returns more than the interest credit rate. To ensure the contribution limit is balanced, you have to contribute less to the cash balance plan in the following year. Contributing less may result in your firm’s balance sheet reflecting more taxable income, meaning; your company will pay more taxes in the following financial year. 

If you own a reasonably large or risk-tolerant firm with significant revenues, you have better flexibility to cope with fluctuations. You benefit from outperforming your plan’s interest credit rate by pursuing more aggressive investment strategies.

A combined fixed income and equity portfolio with between 20% to 40% in equity and 60% to 80% in fixed income can strike a good balance depending on your objectives and the actuarial recommendations.

Cash Balance Plan Investment Options

Using a profit-sharing 401(k) plan with a cash balance pension plan is a great way to maximize your tax-deductible contributions. This type of pension also allows you to avoid paying taxes when you retire.

A cash balance plan is a great way to save for retirement, but it’s important to keep in mind that they are not right for everyone. They are often combined with a profit-sharing 401(k) plan that is already maxed-out. A profit-sharing 401(k) plan is not allowed in a cash balance plan. If you do, you should look for a plan that suits your needs.

A cash balance plan’s investment options are limited. Most participants do not utilize it for their entire life, but they are a good option for small contributions. Unlike a profit-sharing 401(k), cash balance plans are not right for all individuals.

A profit-sharing 401(k) is a good choice for people with a high salary. Nevertheless, it’s not suitable for people who want to invest large sums of money.

Final thoughts

If you’re not making a large contribution, you can consider a 401(k) or cash balance plan. While a 401(k) is a good option for small contributions, a cash balance plan is better for those who are making large contributions.

If you’re unsure of which type of plan to choose, make sure you have a thorough understanding of the investment options before you decide to invest.