When an employer is ready to sponsor a new qualified retirement plan for its employees, it will have many options to choose from. Although “401(k)” may be the first thing that comes to mind, some lesser-known plan types could suit the needs of some organizations under certain circumstances. One example is a cash balance plan.
Allocating credits
Most qualified retirement plans in action today, including 401(k)s, are defined contribution plans. These plans specify the amount that goes into each participant’s account, typically a percentage of compensation or a specific dollar amount. Of course, they don’t guarantee a set return because the plans use investments to accrue balances.
In contrast, a cash balance plan is a defined benefit plan; it specifies the amount a participant will receive in retirement. But unlike traditional defined benefit plans, otherwise known as pensions, cash balance plans express those benefits as a 401(k)-style account balance rather than a formula tied to years of service and salary history.
More specifically, these fully employer-funded plans allocate to participants’ accounts:
- “Pay credits” (generally, a set percentage of annual compensation), and
- “Interest credits” (typically at a fixed rate or a rate linked to an index such as the one-year treasury bill rate).
Doing so allows participants to accrue retirement funds more uniformly over their careers, with a clearer picture of the ultimate benefits than a traditional pension plan provides. Benefits are usually paid out as a lump sum or monthly annuity.
Making larger contributions
Cash balance plans tend to best suit small business owners, but they may also appeal to organizations with high-income professionals (such as health care providers) and those with key employees nearing retirement. The reason why is these plans offer a relatively quick way to build retirement funds for those who, up until now, may have been more focused on their careers than on saving for their golden years.
For example, in 2024, the total limit for employer contributions, employee deferrals and after-tax contributions to defined contribution plans is $69,000 ($76,500 for participants age 50 or older). Contrast that with 401(k) employee contributions, which are limited to $23,000 ($30,500 for participants age 50 or older) in 2024.
What’s more, under the legal mandates for many qualified plan types — including 401(k)s — nondiscrimination rules can reduce contributions even further for business owners and other key employees. The rules are intended to prevent a plan from unfairly favoring highly compensated employees (HCEs).
But the good news is cash balance plans aren’t bound by these limits. For them, the nondiscrimination rules require that only benefits for HCEs and non-HCEs be comparable. Contributions may be as high as necessary to fund those benefits.
Therefore, with cash balance plans, employers may make sizable contributions on behalf of executives and key employees approaching retirement and relatively smaller contributions on behalf of younger, lower-paid employees. The plans are, however, subject to a cap on annual benefit payouts in retirement: $275,000 in 2024.
Of course, there are potential risks to cash balance plans as well. A notable one is that plan sponsors can’t reduce or suspend contributions during financially difficult years. So, organizations considering one generally need to have reliably steady cash flow to ensure funding obligations will be met.
Making the right choice
When evaluating retirement plans for your organization, or reevaluating your current one, be sure to consider all your choices. A cash balance plan may be viable option.
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We highly recommend you confer with your Miller Kaplan advisor to understand your specific situation and how this may impact you.
