In the world of science and engineering, a black box is a device, system or object which can be viewed solely in terms of its input and output without the user knowing how it works. In our ERISA world, a Cash Balance plan be a black box into which employer contributions are made on a tax deductible basis and benefits at some point are paid out.
So let’s take a peak inside the black box to help you better understand how a Cash Balance plan works so it could better accomplish your objectives. Here is a brief overview in Q & A format.
What exactly is a Cash Balance Plan?
A Cash Balance Plan is a defined benefit plan that specifies the amount of contribution to be credited to each participant and guarantees the investment earnings on those contributions. Each participant has an individual account that resembles the accounts in a 401(k) profit sharing plan. All participant accounts are administered by a pension firm such as ours who generates annual participant statements.
What counts as “earnings” for purposes of contributing to a Cash Balance plan?
Pension law limits your earnings for retirement plan purposes to a maximum of $265,000 in 2016. Your legal form of business entity determines what income can be counted for retirement plan purposes. If you are a:
- Sole proprietor compensation, it is Earned Income
- Partnership, it is also Earned Income
- C-corporation, it is W-2 income
- S-corporation, it is also W-2 income but dividends cannot be included
- LLC, it depends on how it is taxed (partnership or corporation rules apply)
Must everyone participate equally in the Cash Balance Plan?
No. The amount can be a percentage of pay or a flat dollar amount. Each participant can have a different contribution amount, but the plan, like any other qualified plan, is subject to nondiscrimination testing.
Is a Cash Balance plan subject to “Top-Heavy” rules?
Yes. A plan is top-heavy if more than 60% of the value of the benefits under the plan has been accrued by key employees. In such cases, the plan must provide certain minimum benefits and vesting
How are plan investments handled?
Plan assets are pooled and invested by the trustee or investment manager. The accounts of the participants will be credited with interest at a rate guaranteed by the plan regardless of the actual investment return.
What happens when a participant terminates?
A Cash Balance Plan like other qualified retirement plans must have a vesting schedule. Vesting is based on Years of Service (1,000 hours or more a year). Once participants terminate employment, they will be eligible to receive the vested portion of their account balance, which is determined by the plan’s vesting schedule.
Is a Cash Balance plan covered by the Pension Benefit Guaranty Corporation (PBGC) plan termination insurance program?
It depends. Certain plans are exempt such as a plan that covers only substantial owners and plans sponsored by a professional service employer, e.g., law firm, accounting firm, medical practice that does not have more than 25 active participants.
Can an employer maintain both a defined benefit pension plan and a defined contribution plan, i.e., 401(k)/profit sharing?
Yes. Under the tax law, it may be possible to significantly enhance benefits and contributions for owners and other High Compensated Employees provided that non-discrimination tests and tax deductibility rules are met.
When is the employer contribution due for funding purposes?
The contribution is due no later than 8 ½ months after the end of the plan year, September 15th for calendar year plans. If the contribution is not timely made, there can be an excise tax of 10% of the amount that should have been contributed.
Can a Cash Balance Plan be frozen or terminated?
Yes, a Cash Balance Plan can be frozen or terminated subject to the same rules that apply to other qualified retirement plans.
Are Cash Balance benefits subject to creditors?
Employer sponsored retirement plans, Cash Balance plans, are protected from creditors by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Act”) as well as a specific ERISA statutory provision. This asset protection feature is an important one to owners and partners of professional firms.
Who is a good candidate for a Cash Balance plan?
Here a few considerations in deciding whether to adopt a Cash Balance plan.
First and foremost, an employer should consider a Cash Balance plan is it is profitable and has predictable revenue. It is a retirement plan with recurring contributions.
Second, the owners or partners are generally at least 40 years of age and earn at least $100,000 per year.
Third, they want to accelerate their retirement savings by contributing more than the annual maximum of $53,000 ($59,000 if age 50 or older) to a 401(k) and profit sharing plan.
But, of course, each employer’s situation is different, and this explanation of Cash Balance pension plans is necessarily brief. It’s provided for general information purposes only and should not be considered tax or legal advice. Employers should always check with a qualified tax advisor for the application of the tax laws to their specific situation.