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Questions You May Have About a Cash Balance Plan

This information may help you evaluate whether a Cash Balance Plan is the right next step for you.

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What type of business can establish a Cash Balance Plan?

Any business can establish a Cash Balance Plan, including sole-proprietorships, partnerships, corporations, and other types of entities. Cash Balance Plans are most suitable for highly profitable businesses with stable cash flow. 

How much can be contributed and deducted?

With the right demographics contributions between $100,000 and $200,000 for owners or high-compensated employees can be contributed. All contributions are fully deductible to the business for federal income tax purposes. 

Why types of investments are appropriate?

It is important to select investments that compliment your Cash Balance Plan because these plans are designed to target a specific rate of return between 4% and 7%. Choosing investments whose return fluctuates significantly from the target rate of return can cause an increase or decrease in the required annual funding of the plan. 

Can a Cash Balance Plan be combined with another Plan?

Yes. Cash Balance Plans work best when combined with 401k Plan. This provides for flexibility to the employees and employer in funding contributions yet allows for maximum contributions. Owners and highly compensated employees may be able to receive $61,000 plus in the 401k plan plus much higher contributions ($100,000 plus) in the Cash Balance Plan. 

Are contributions required each year?

Yes. Although it is possible for the minimum required contribution to be zero, annual contributions are not discretionary and are required to be made to fund the plan’s stated benefit each year. 

Must all employees receive the same benefit levels?

No. Cash Balance Plans can be designed with different benefit levels for targeted groups of employees or specific individuals. 

What are the risks associated with cash balance plans?

A properly designed Cash Balance Plan implemented can be a great retirement savings plan, but it has risks that should be evaluated carefully before implementing. 

Required Contributions – Contributions to a Cash Balance Plan are not discretionary and are required to be funded each year until the plan is terminated. 

Fluctuation in Contributions – Several actuarial factors can cause contribution amounts to fluctuate from year-to-year. If the actual return from the plan’s investment portfolio differs significantly from the plan’s target rate of return, the required contribution can vary significantly from year-to-year. In addition, changes to the company’s employee makeup can cause contributions to fluctuate. A third factor that can cause contributions to fluctuate is an increase or decrease in interest rates. As interest rates decrease, required contributions increase and vice versa. 

When must I fund contributions to my Cash Balance Plan?

Contributions are required to be funded by the earlier of the filing of the company’s federal income tax return or 8 ½ months following the end of the plan year. For a calendar year plan, the latest date that the contribution can be funded is September 15th. 

What if I cannot fund contributions by the due date?

Contributions not funded by the due date will incur an automatic 10% non-deductible IRS excise tax. The IRS may increase the tax up to 100% at its option. 

What is the required frequency for funding contributions?

Many plans have minimum quarterly contributions that must be made; however, if your plan is 100% funded then you may be allowed to fund contributions less frequently. 

What are the minimum benefit and contribution levels?

A Cash Balance Plan must cover the smaller of (1) 50 employees, or (2) 40% of the group. Each employee in the plan must receive a “meaningful benefit”. According to the IRS a meaningful benefit is equal to at least ½ percent of pay at retirement for each year of service which often approximates a 2% to 3% annual employer contribution. 

How is compensation calculated?

Compensation is generally defined as income from employee’s W-2. For sole proprietors or owners of entities taxed as a partnership, compensation is defined as the owner or partner’s Net Earnings from Self Employment (Income from Schedule C or K-1). 

Does a Cash Balance Plan require the services of an enrolled actuary?

Yes. An enrolled actuary is required to calculate contribution range, to certify the annual valuation, and to calculate participant distribution options. The JULY enrolled actuarial team will provide these services for your plan. 

What type of insurance coverage is required?

Cash Balance Plans are generally required to carry two types of insurance to cover the plan: 

PBGC Insurance – The Pension Benefit Guaranty Corporation (PBGC) is the federal corporation that insures most defined benefit plans, including Cash Balance Plans. Plans are required to obtain coverage from the PBGC and premiums generally cost about $38 per participant. Some exceptions apply to this rule, including:

o Owner-Only Plans 

o Professional Service Firms with 25 or fewer participants 

Fidelity Bond Insurance – Plans are required to obtain Fidelity Bond Coverage in the amount of 10% of plan assets with a maximum of $500,000. This policy is to protect against fraud or dishonesty. Owner-Only Plans are exempt. 

What distribution options are available?

The plan generally expresses retirement benefits in the form of a lifetime annuity at retirement, but lump sum payment options are also permitted. 

Can the plan apply a vesting schedule to participant benefits?

Yes. Any vesting schedule can be chosen as long as participants are fully vested after 3 years. 

How are forfeitures treated in a Cash Balance Plan?

Forfeitures of unvested benefits reduce future employer contributions. They are not reallocated among the participant’s hypothetical account balance. 

What if I can no longer fund my plan?

It is possible to amend the plan to reduce or freeze benefits in any given year; however, action must be taken early in the year to make the change effective for the year in question. Once participants have worked 1,000 hours during the year, they are generally entitled to benefits at the higher level. Freezing benefits does not automatically mean zero contributions. However it generally means substantially reduced contributions. 

How long should the plan be in place?

Defined Benefit plans, including cash balance plans, are required to satisfy a Permanence Requirement. IRS guidance states that a DB plan may be terminated for a legitimate business reason such as: 

• Business restructuring, such as a merger, change in stock ownership, or bankruptcy reorganization, 

• A change in law affecting qualified plans, 

• The substitution of another plan, 

• Financial Hardship 

Apart from these reasons IRS has issued guidance stating that they interpret 10 years as satisfying the permanence requirement. Some believe a shorter timeline could be permanent in some situations. 

Because of the fact that the only written guidance states 10 years, if you anticipate maintaining your plan for a shorter time, we recommend that before adopting the plan you consider discussing this with your attorney to the extent you consider appropriate or necessary. 

How frequently can I amend the plan to freeze, increase, or decrease benefits and contributions?

Plans should only be amended to increase or decrease the benefits and contributions for valid economic reasons. As a result, plan sponsors with unpredictable cash flow and profits should carefully consider adopting these plans to avoid running afoul of this rule. If valid economic reasons exist, the plan can be amended. 

What is shown on the annual participant statement for a Cash Balance Plan?

The annual participant statement for each participant will show the beginning balance, contribution credit, interest credit, distributions, and ending balance. It will also show the vested portion of the participant’s benefit.