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A Look at Cash Balance Plans for Business Owners

Like other closely held business owners, earlier in your career you probably devoted a considerable amount of your resources to building your company. Now that you are getting closer to retirement, you may be looking for ways to beef up your retirement benefits. One option to consider is a cash balance plan.

A cash balance plan could provide you and other key employees with greater retirement benefits and give your company additional tax deductions. Cash balance plans combine some of the best features of a traditional defined benefit plan and a defined contribution plan. They tend to be less expensive than traditional defined benefit plans and may be easier for employees to understand. Employees who understand the advantages of a plan are more likely to appreciate the benefit you are providing to them.
 
“. . . a cash balance plan may allow your company to make annual deductible contributions on behalf of owners and key employees that are greater than the maximum contributions permitted under a 401(k) or other defined contribution plan.”

How the Plan Works

With a cash balance plan, you create a hypothetical plan account for each plan participant and credit the account annually with a percentage of the employee’s pay (or a flat dollar amount) plus interest. The interest rate can vary from year to year and is commonly tied to an industry benchmark specified under the plan. Benefits generally are paid out as an annuity or in a lump-sum distribution.

Employer plan contributions are pooled and invested in securities chosen by the employer. Employees receive regular statements showing the accumulated balances in their accounts, but these balances are merely “on paper” until the employee retires or leaves the company. When participants receive a lump-sum distribution from the plan upon retirement or a job change, they generally can roll over the amount to an individual retirement account (IRA) or another employer’s plan. This portability is an attractive feature to many employees.

Benefits

In addition to being less costly than a traditional defined benefit plan, a cash balance plan may allow your company to make annual deductible contributions on behalf of owners and key employees that are greater than the maximum contributions permitted under a 401(k) or other defined contribution plan. Within limits, contributions can be made according to a formula that increases the annual benefit based on age or service. You may also have the ability to fund higher contributions in years when the business does well.

Considerations

A big drawback of this type of plan is that the employer bears the investment risk. Benefits are based on the plan’s formula and do not vary with the performance of the plan’s investments. With a 401(k) or other defined contribution plan, the employee bears the risk since benefits are based on actual account balances.

Another consideration is your company’s cash flow. Cash balance plans require annual company contributions. Unlike a 401(k)/profit sharing plan, you don’t have the option of suspending employer matching contributions or not making profit sharing contributions in years your company isn’t doing as well as usual.

An Attractive Alternative

A cash balance plan can be an attractive alternative to traditional plan designs for both employers and employees. Or, if you already have a 401(k) plan in place, it can be added as a supplementary retirement plan. If a cash balance plan sounds like an option worth exploring for your company, give us a call. We would be happy to go over the benefits and requirements with you in more detail, including how you could convert an existing defined benefit plan to a cash balance plan.