If there existed a place called “The Museum of the American Workplace,” the typewriters, fax machines, and other relics would likely be accompanied by an exhibit of traditional defined-benefit pension plans. Once a bedrock of employer-based retirement savings, traditional pension plans have been under siege and disappearing from the American workforce for decades, replaced by 401(k)s and, in increasing numbers, cash-balance plans. Cash balance plans combine characteristics of both traditional pensions and 401(k)s, held $1 trillion in assets worldwide in 2014, and such plans made up 29 percent of all defined benefit plans in 2016.
Cash balance plans vs defined benefits
Cash-balance plans share characteristics of both traditional pensions as well as 401(k)s. Investments are professionally managed and pooled into a single fund, employers make contributions to the employee’s account based on a percentage of their salary (usually around 5%) as well as an interest credit (also around 5%), and participants are promised a specific benefit upon retirement.
Unlike 401(k)s, where a plummeting market could wipe out an employee’s retirement savings, employers are the ones who bear the investment risks in a cahs-benefit plan. The amount of the promised benefit will be the amount of the promised benefit.
Upon retirement, the employee can take the benefits as a lump sum or choose an annuity to be paid out over time. As with 401(k)s, accrued benefits are portable and can be rolled over into an IRA or another qualified plan when an employee changes jobs.
Why Cash-Balance Plans Are Attractive to Small Business Owners and Professional Practices
Cash-balance plans are a particularly attractive option for small business owners who may not be satisfied with either the returns or contribution limits of a traditional 401(k). It is an even more attractive option for older business owners who may be trying to make up for lost time in their retirement planning.
Cash benefit plan contribution limits favor older workers
With a 401(k), an owner 50 years old or older is limited to an annual pretax contribution of $57,500. Cash-balance plans, on the other hand, have much more generous limits that continue to increase as the participant gets older. For example, a 60-year-old owner now seeing the fruits of decades of work but who may have spent less time thinking of retirement can now play make-up, putting away over $250,000 annually in pre-tax contributions.
Taxes and cash benefit plans
Since cash-balance plans are “qualified plans,” the tax savings afforded by these significantly higher contribution limits offset the costs of sponsoring a cash-benefit plan, which are typically higher than for 401(k)s. Typical costs can include setup fees of between $2,000 to $5,000 in setup fees, annual administration fees of between $2,000 and $10,000, and investment-management fees between 0.25% to 1% of assets.
Whether a cash-balance plan is right for your small business, either as a stand-alone retirement savings vehicle or as an adjunct to other plans, depends on your specific circumstances. If you have questions or concerns about cash balance plans or other retirement savings issues and need clear, actionable guidance, please contact us. We welcome the opportunity to assist you.