Spring/Summer Series Part 6: Cash Balance Plans.

In an earlier episode of this series, we talked about comparability profit sharing plans. Then in our last episode, we talked about defined benefit plans. Think of the cash balance plan as a hybrid of these two plans. So let’s compare some points of the three plans, in no particular order of importance:

• In a defined benefit plan, owners of different ages will have different contributions. In the cash balance plan, the contribution for each owner can be the same.
  
• In the comparability plan, it is possible for the owners to have the same contribution, but the limit is $62,000. In a cash balance plan, it could be much higher.
• A comparability plan is a pure account balance plan, in which the participant’s retirement benefit is exactly what is contributed plus earnings until retirement. A defined benefit plan is not account balance; a participant’s benefit does not change based on investment performance. A cash balance plan is a combination; a minimum rate of return is stipulated in the plan, but earnings above that go toward the participant’s account balance.
• For a new defined benefit plan, a small number of older employees can make the plan too costly for the company to adopt. Looking at average benefits in the cash balance plan could mitigate this.
• Average benefits could mitigate the cost factor in a comparability plan as well, but once again we’re faced with a lower contribution limit.
• In a situation where almost all of the employees are older than the owners, a cash balance plan would probably not work well. It’s not magic, after all. But in that case, neither of the other plans would work well, either. Your actuary would never mislead you about this.
  
  

Basically, the cash balance plan is a tool like any other qualified plan. In some situations it works well, and we can design a plan that disproportionately benefits the owners without running afoul of the Internal Revenue Code. In other situations you’d want to look at a different type of plan. That’s where your actuary’s expertise comes in. Provide her with a census of employees, let him know the company’s objectives, and he or she will lay out your best options.

I’ve enjoyed writing the Spring/Summer Series, in part because it reminds me how complex the world of pensions is. You can’t really do justice to it in 500 words on each topic, or at least I can’t. I tried to keep things brief and interesting. I’m always happy to answer any questions, especially those that arise because my writing was too brief. (Or too interesting!) And I’m always happy to provide a proposal for your client. Let’s do some business together!

Next up: related examples of plan design that are not technically part of the Spring/Summer series. Which is good, because Spring/Summer is just about over.