By now you have probably heard all about cash balance plans. But there are a few downsides. So in this post, we’ll discuss the cash balance plan pros and cons.
One of the biggest pros of cash balance plans is that they are not limited to one employee. If you work for a small business, you may be able to begin with $50,000 and gradually increase your contributions to save for retirement.
It is especially beneficial for older employees, because they can quickly remove excess cash from their company in a tax-efficient manner. However, some people find this plan difficult to manage. If you’re thinking about enrolling in a cash balance plan, make sure to know what its pros and cons are.
Table of contents
The Basics
Let’s be truthful. The defined benefit plan formula is complex.
But it doesn’t have to be. There are a few critical components to the calculation. But once you get those down, it will not be that tough.
This guide will examine the calculation and discuss how this is applied in practice. We’ll try to make this easy on you.
The employer must contribute by the tax due date or the extension to take advantage of tax benefits. The required minimum funding contributions must be made within at least 8 ½ months following the plan year-end.
The cash balance plan may differ for each employee. The contribution amounts are determined based on compensation, job responsibilities, length of time with the company, etc.
So now that you understand the basics, let’s look at some specific details.
As a pension plan, a cash balance plan is a retirement vehicle offered by employers to qualified employees of a company. The employer will set a contribution percentage of the employee’s yearly compensation plus an interest credit to an account designated for the employee’s retirement.
What are the advantages of a cash balance plan?
There are many advantages, so let’s highlight a few of them:
- Large contributions. Funding is substantially higher compared to 401k plans and SEPs.
- Funding flexibility. You are given a funding range that allows for minimum and maximum contribution levels.
- Age-weighted contributions. Contributions will increase with age, allowing owners who are close to retirement higher funding.
- Ability to combine with other plans. These plans can be easily integrated with other retirement plans (like 401ks) that allow maximum benefit.
- Tax deductible. Because these are qualified plans, all contributions are tax-deductible.
What are the cash balance plan disadvantages?
As with any qualified plan, there are downsides. Let’s list out some of them.
- Permanency. These plans are not elective, and, as a general rule, annual contributions are required.
- Plan fees. Each plan requires an actuary sign-off. This dramatically increases the cost.
- Conservative investments. The plans come with an interest credit of usually 5%. You should try to minimize volatility and match this rate if possible.
- Increased complexity. These plans can be challenging to understand.
While many people prefer a traditional pension plan, cash balance plans don’t have that flexibility. Although they have annual contribution limits, you can contribute more than the average employee. Additionally, they often have flexibility in the way they credit contributions.
In some cases, the amount of credit is a percentage of a participant’s pay, while others prefer a flat dollar amount. In either case, the difference between the interest crediting rate and the actual performance of the investments must be made up by the owners.
Can Be Combined With Other Plans For Increased Savings
Cash balance plans work well with traditional 401(k) plans, income distribution plans, or any other revenue-allocating method to generate more significant retirement savings for their participants. They can also be modified to fit different specifications required by every participant within a company, based on age and income levels.
Another benefit of cash balance plans is that they can be flexible, which is great for small business owners. However, this type of plan does have its drawbacks. Its high cost is a major disadvantage for employers, especially small business owners and solopreneurs.
The investment options are limited, and the conversion process is complex. Because the benefits are based on salary over the course of an employee’s career, cash balance plans tend to be more popular with smaller businesses and solo entrepreneurs.
Another advantage of cash balance plans is that they can be less expensive to maintain than defined contribution plans. Also, record keeping is easier and simpler with a cash balance plan because there is no need to reconcile the trust assets.
IRS Approval
IRS approved the cash balance plans by issuing final regulations in 2014 to support its concept as a viable retirement plan. This approval rests the worries many have over cash balance plans and boosted its acceptance.
Cash Balance Plans Have Life-Changing Impact
A large amount of savings can be amassed over a short period under cash balance plans. Business owners and key employees in medical fields with high incomes prefer to quickly secure their retirement future through boosted retirement savings.
What are the disadvantages?
Furthermore, because employees don’t make contributions, cash balance plans are more flexible. The downsides of cash balance plans are outlined below. They are beneficial for small businesses and solopreneurs who have high salaries.
While cash balance plans are not for everyone, they are still beneficial for many people. A cash balance plan is often a great choice for a small business, as it allows employees to have more flexibility with their contributions. Take a look at the cash balance plan pros and cons.
It is also possible for solopreneurs to set up a cash balance plan as an alternative to a 401(k). But there are some important differences to consider. These pros and cons are described below.
The biggest disadvantage of cash balance plans is that they are not a good option for every business. Since cash balance plans are defined benefit plans, the employer is responsible for making sure the end balance is what was promised.
While the end balance is usually conservative, the excess investment returns give flexibility to the employer. They can use the money to improve the company’s portfolio and get it back in line with its target growth rate. If your company’s cash balance plan is not appropriate for your needs, you can always hire a qualified financial adviser to ensure you receive the maximum benefits.
For the employer, cash balance plans are a good option for the tax benefit of the plan. The employee will not pay taxes on the money he or she contributes, but the employer will, in most cases, invest it in the stock market. This way, the company won’t pay taxes on the money until the employee withdraws it.
A cash balance plan is a great solution for succession planning. In short, it’s a great way to keep your employees happy and healthy.
| Large Contributions | Plan contributions are often as high as $300,000 |
| Funding Flexibility | Each year you will receive a funding range that will scale based on your business income or W2 |
| Combining Plans | Approximately 90% of our plans are combined with a 401k plan. |
| Tax-Deductible Contributions | They qualify for immediate tax deferral. |
| Age-Weighted | Most high earners tend to be older, and this helps. |
Final thoughts
For business owners, cash balance plans are the best option. For one, they have lower administrative costs than traditional pension plans. Secondly, they are more user-friendly. If you own a business, cash balance plans can be a great option for employees.
They are more convenient and effective for those with multiple employees, but their costs are higher than those of other pension options. You should be careful, however, as cash balance pensions are not the best solution for every situation.
Cash balance plans, as explained, have unmatched savings opportunities and flexibility for business owners and high-end employees. However, the plan s associated with complex rules and regulations managing their use.
Any business considering a cash balance plan should work with a third-party administrator (TPA) and a tax expert to ensure maximum gains from a cash balance plan.