How Does Cash Balance Work?
Summarizing how a typical cash balance plan works, the participant has a ‘hypothetical account’ that looks on the surface like a savings account. Each year, each participant’s account receives a percent of pay. This is called the ‘pay credit.’ The account earns ‘interest credits’ at a rate stated in the plan. One major difference between cash balance and 401(k) plans is that in a cash balance plan, the trust is invested as a whole. There are no actual individual accounts. The plan sponsor selects the investments of the trust; plan participants don’t have a say.
More About Final Regulations
The regulations provide explicitly for the rates that may be used as the interest crediting rate. They include both fixed and variable rates. The maximum fixed rate is 6%, increased from 5% in the proposed regulations. The fixed rate is a very popular option with many cash balance plan sponsors. Variable rates may be tied to an index such as the return on an equity fund. A plan may also provide for an interest crediting rate equal to the actual return on the trust, although this option comes with certain restrictions and can be problematic in administration. One important consideration is that when a variable rate is used, there is a ‘preservation of capital’ rule which states that the minimum cumulative rate of return is zero.
Plans may implement an annual floor. For rates related to government bonds the minimum annual rate is 5%. For rates related to investment grade corporate bonds (i.e. government mandated funding rates) the annual minimum rate is 4%. For actual rate of return the minimum allowable rate is a cumulative 3% rate.
The regulations contain rules allowing sponsors to amend plans to transition from an interest crediting rate that is not permitted under the final regulations to one that is permitted.
If you have questions about cash balance plans, we are happy to assist you. Please contact the JULY Sales Team for additional information: InsideSales@julyservices.com or 888.333.5859, ext. 418.