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Cash Balance Defined Benefit Plan FAQs with Example

Q.         What is a cash balance plan?

 

 

A.

A cash balance plan is a defined benefit pension plan structured to look like a defined contribution plan.

 

In a cash balance plan, each participant has an account that is credited with:

 

(a) pay credits specified in the plan document; and

(b) guaranteed interest credits based on a formula specified in the plan document

 

Pay credits can be targeted to benefit specific groups of participants provided that IRS non-discrimination requirements are satisfied.  When a participant terminates, they can either take the vested portion of their account balance in a lump sum or request that it be converted into a monthly annuity that would be payable for the rest of the participant’s life.

Q.         Can cash balance plan contributions change from year to year?

 

Unlike a profit sharing plan, pay credits under a cash balance plan are fixed at the rates specified in the plan document.  While the plan document can be amended to modify pay credits prospectively, IRS non-discrimination requirements limit the plan sponsor’s ability to make such changes.

 

Unlike a profit sharing plan, pay credits under a cash balance plan are fixed at the rates specified in the plan document.  While the plan document can be amended to modify pay credits prospectively, IRS non-discrimination requirements limit the plan sponsor's ability to make such changes.

 

In addition, the IRS requirement that defined benefit pension plans be “permanent” applies to cash balance plans.  To satisfy this permanence requirement, the plan sponsor should intend to maintain the plan for at least five years or have a good business reason for terminating the plan within five years of it being established.

 

 

 

A.

Q.         What types of plan sponsors are good candidates for cash balance plans?

 

 

Plan sponsors with the following characteristics:

 

The plan sponsor’s principals are, on average, older than the rank-and-file employees.

 

The plan sponsor’s principals are interested in contributing more than the maximum defined contribution plan contribution ($52,000 for 2014 plus, if applicable, the $5,500 401(k) catch-up contribution, totaling $57,500).

 

The plan sponsor is prepared to make a staff contribution of 6% to 8% of rank-and-file employees’ salaries to the retirement plans.

 

The plan sponsor’s cash flow is sufficient to fund the cash balance plan pay credits and employer profit sharing contributions.

 

Plan sponsors that already sponsor “cross-tested” or “new comparability” profit sharing plans, can be particularly good candidates for cash balance plans because cash balance plan pay credits can be age weighted to maximize the amounts allocated to the plan sponsor’s principals.  

 

 

 

 

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