Cash Balance plans are variations on traditional defined benefit pension plans but appear to the participant like a 401(k) plan. As in a traditional pension plan, investments are aggregated for the benefit of participants. Individually directed investment accounts are not available in a cash balance plan. And participants are promised a certain benefit at retirement. But that promised benefit is presented as a 401(k)-type account balance, rather than as a monthly income stream.
These plans, like traditional defined benefit plans have generous contribution limits that increase with age. People 60 and older can sock away well over $200,000 annually in pretax contributions. In 401(k) s, total employer and employee contributions for those 50 and older are limited to $57,500.
Changing from a traditional defined benefit plan to a cash balance plan can trigger a benefit cut. One reason: While traditional pension benefits tend to be based on a participant’s final working years, when salary generally peaks, cash-balance benefits are based on all working years, including those when earnings were lowest.
Older business owners making more than $250,000 a year may be ideal candidates to establish a cash-balance plan. Plan contributions reduce adjusted gross income, resulting in potentially significant tax savings
Contributions for rank and file employees into cash-balance contributions range typically from 5% to 8% of pay, compared with the 3% contribution that’s typical in a 401(k) plan. Participant accounts also receive an annual “interest credit,” which may be a fixed rate, such as 5%, or a variable rate, such as the 30-year Treasury rate. At retirement, participants can take an annuity based on their account balance. Most small employer plans offer a lump sum, which can be rolled into an IRA or another employer’s plan.
These plans can be more expensive for employers than 401(k) plans, partly because an actuary must certify each year that the plan is properly funded. Typical costs include $2,000 to $5,000 in setup fees, $2,000 to $10,000 in annual administration fees.