A Cash Balance Plan is a kind of Defined Benefit Plan that works differently from other types of retirement plans. This article will give you some general information about how the Cash Balance Plan we formulate operates, and the benefits of utilizing a Cash Balance Plan to help achieve your retirement savings goals.
Majority of the Cash Balance Plans we formulate are designed for the primary benefit of the proprietors or officials of a company. As a result, the contributions for proprietors and officials are normally huge with littler contribution provided to staff to meet the requirements of the IRS. When designing the plan, the sponsoring organization chooses the amount of contribution for each proprietor and official, up to the greatest sum allowed by law.
Only business organizations can sponsor a Cash Balance Plan, but any business entity is still allowed to sponsor a Cash Balance Plan. We give administrations to sole proprietorships, organizations, LLCs, philanthropies, and partnerships. You don’t need any representatives other than yourself.
The number of organizations sponsoring Cash Balance Plans is increasing geometrically. Some of the reasons for the geometrical increase are:
- Higher expected tax rates for sole proprietors and experts.
- Increased number of sole proprietors who are nearing retirement.
- The American Government’s desire to have privately funded pension plans to help finance the retirement of America’s employees.
- The need for bigger retirement contributions due to market fortunes in existing retirement accounts that can’t be deducted in Defined Contribution Plans
- The development of Cash Balance Plans as an acknowledge method for controlling Defined Benefit Plan employee cost while still maximizing deductions for the owners.
Before starting a Cash Balance Plan, you ought to have a good idea of how a Cash Balance Plan works since its mode of operation is quite different from that of a 401(k) Profit Sharing Plan or a Traditional Defined Benefit Pension Plan. This is why you may hear people refer Cash Balance Plans to as “Hybrid” Plans. Cash Balance Plans typically offer the benefits of the high contribution limits of Defined Benefit Plans with the ease of understanding of Defined Contribution Plans.
HOW DOES CASH BALANCE PLAN WORK?
Under a Cash Balance Plan, a “Speculative Account” is set up for each participant. This is account is not within the plan’s trust account. Rather, the plan administrator controls the accounts; thus, they are qualified as Hypothetical Accounts. Contributions are deposited into these accounts annually in agreement with formulas specified in the plan document. Annually, interests are also credited into the accounts based on a rate chosen by the plan sponsor. Generally, this rate is between 4% and 5% or it is based on the dividends of an index e.g. 30 year treasury yield.
When a participating employee quits job, he or she qualifies to receive the fixed and absolute portion of their hypothetical account balance. A participating employee fixed percentage is set by the plan document and can be 0% for up to 3 years of active service and then must be 100% upon culmination of 3 years.
CHANGES IN PARTICIPANT CONTRIBUTIONS
The sums which can be contributed from annually are made to undergo complex favoritism testing. That is, we should ensure that contributions made for heavily remunerated individuals bear a sensible relationship to the contributions made on behalf of individuals who are not heavily compensated. In carrying out the discrimination test, we are allowed to combine the cash balance contributions with the contributions the participating company is providing in other retirement plans. The sum of the required contribution is contingent upon employee demographics. So, the contributions can vary from annually, however we do our best to limit those variances and give a projection of upcoming contributions for nothing out of pocket to our customers so you can roll out an improvement if the contributions for the year are not meeting your company goals.
LIMITS ON CHANGING PARTICIPANT CONTRIBUTIONS
Once an employee has worked 1,000 hours during a plan year, the business must make a contribution on his or her behalf and cannot revise the plan to lower the measure of the contribution. This is true regardless of whether the participating employee even subsequently terminates employment during the year. For most full time workers, 1,000 hours will be gone for a timetable plan year in June.
PLAN AMENDMENTS TO CHANGE EMPLOYEE BENEFIT ACCRUALS
The plan can be revised regularly to allow distinctive contribution levels, but there are some limits to this. For instance, contributions cannot be revised to an amount that would cause the discrimination test to fall flat.
The plan can be revised to increase contributions but this must be done before the end of the year for Highly Compensated Employees. Non-Highly Compensated Employees can be expanded whenever.
Plan changes which will diminish contributions must be made 15 days before any affected participating employees complete 1,000 hours of service in a plan year.
The plan is designed to be permanent Defined Benefit Plan and not a deferral plan. So, revising the plan to increase and diminish contributions annually is not allowed. A general dependable guideline is that an amendment should be put into focus for at least 3 years; however there are exceptions for certain unforeseeable business conditions.
Individual participants are unable to coordinate the investment of their account as the plan assets will be pooled and invested by the trustee (for the most part the business owner or owners). The hypothetical accounts of the participating employees will be credited with interest at a rate stipulated by the plan document. In the event that the actual trust profits surpass the ensured rate, the overabundance will be utilized to lessen future employer contributions. This will not influence the amount credited to the participating employees’ accounts. That is, the account will expand according to the plan’s schedule and the increase will be financed partially from employer/business contributions and partially from the abundant profit.
EMPLOYER CONTRIBUTION AND THE CONTRIBUTIONS TO PARTICIPANT ACCOUNTS
Usually, the employer/business contribution will not be quite the same as the amounts added to the accounts. This is principally because of contrast between the interest that is credited to the accounts and the profit realized from the plan’s investments, and it can also be due to vesting or changes in IRS required assumptions.
PAYMENT OF HYPOTHETICAL ACCOUNTS
All in all, the hypothetical account in a Cash Balance Plan can be paid as a complete sum distribution to a participant upon death, disability, retirement, or termination of service. In the event that the monetary value of the account exceeds $5,000, the participating employee must also be given the opportunity to select payment of an annuity in place of a lump-sum. Payment of a lump-sum distribution may be limited if plan assets are not adequate. For this reason, values are placed on the account using rates of interest and mortality recommended by the IRS. If assets are not enough, the employee may be limited to receive only the annuity form of payment or wait until assets are adequate to take a lump sum. If the contribution we prescribe each year is made, such limitations rarely occur.
PBGC INSURANCE PREMIUMS
All in all, the advantages of Cash Balance Plans are safeguarded by the PENSION BENEFIT GUARANTY CORPORATION (“PBGC”); nonetheless, if the organization is a professional service firm with less than 26 dynamic participating employees, the plan is not secured by PBGC. Plans that are secured by PBGC insurance must pay a premium to the PBGC every year ($69 per participating employee beginning in 2017). In the event that the plan investments do not perform enough or the plan sponsor makes not exactly the recommended contribution, the plan could be dragged by unfunded benefit liabilities. Unfunded benefit liabilities will increase the make the premium to be paid high.
TAX DEDUCTIONS AND ALLOCATION OF PLAN CONTRIBUTIONS
The manner in which the tax deduction for the contributions to a Cash Balance Plan is taken is contingent upon the entity of the plan sponsor. The contributions for non-proprietors are always a company tax deduction. The proprietor contributions are either a company tax deduction or a personal tax deduction depending on whether or not the plan sponsor is a business enterprise.