5 considerations when proposing cash balance plans to clients

By Jerry Cicalese

Cash balance plans have eclipsed traditional defined benefit plans in popularity since the Pension Protection Act passed in 2006. Plans with fewer than 100 participants have grown 336% over the past 10 years versus 9.4% for plans with greater than 100 participants over the same period, according to a December 2021 Plan Sponsor article by Rebecca Moore.¹

A cash balance plan is a type of tax-favored or “qualified” retirement plan that allows for tax-deductible contributions exceeding those permitted in a profit-sharing or 401(k) plan. Each participant in a cash balance plan receives a contribution credit each year equal to a flat dollar amount or a percentage of compensation, as well as a guaranteed interest credit. Because each participant has an “account balance,” a cash balance plan is easier to understand than a traditional defined benefit plan. The funds must be placed in a pooled trust that is maintained in the plan’s name and managed by the plan’s investment advisor.

For employers, cash balance plans are an excellent retention tool, offer less risk than traditional pension plans, and are easy to manage. Employees also benefit because the plan is easy to understand and builds their retirement savings faster than a traditional 401(k) plan. In other words, it’s a win-win.

Here are five considerations for advisors when proposing cash balance plans to your clients. Also, bear in mind that you’ll need to partner with a third-party administrator because an actuary will be required.

1. Cash balance plans aren’t for everyone. 

Despite their popularity, cash balance plans are not the right fit for every company. Professional service organizations such as law and accounting firms or medical institutions are a particularly good fit because high-earning employees have significant sums of money that can be placed into the tax-deductible trust.

On the other hand, larger companies with many low- or mid-level employees may struggle to reap the same tax benefits, due to the employees’ lower salaries. That’s not to say it can’t be done. For example, manufacturing companies, according to Moore’s reporting, make up 11% of all cash balance plans, but it is likely that a company’s size and the earning power of its employees will influence whether switching to a cash balance plan makes sense. 

2. Layering plans can save a company (and its employees) significant fees. 

Cash balance plans are often used in conjunction with 401(k) defined contribution plans. These plans are often referred to as combo plans. If designed appropriately, employer contributions from a 401(k) plan are used toward offsetting the minimum required contributions of a cash balance plan.

The ideal candidate is a retirement plan in which the business owners are maximizing their contributions to the $61,000 (plus catch-up) current maximum amount allowed in a 401(k) plan because it may only cost another 2% to 3% to the staff to get the business owner/senior leaders another $100,000 to $200,000 of tax-deductible contributions. Compared to 401(k) plans, cash balance plans have larger contribution limits that increase with age, which allows for these larger annual contributions. Total annual tax-deductible contributions in plans like these can exceed $300,000 per owner. 

3. Cash balance plans attract and retain talent. 

A cash balance plan can be used to attract, retain, and reward key people. Rather than equity and ownership, or higher taxable salary and bonus, an employee may receive an allocation of perhaps $50,000 or $100,000 over 10 years. This is especially enticing for an individual who wishes to retire early or who neglected their retirement savings earlier in their career, or who wishes to receive a tax-deferred retirement contribution rather than additional salary or bonus that can result in a higher current tax liability.

In addition, by allowing participants to condense years of savings into a much smaller period, cash balance plans can reduce current taxes. Be aware that cash balance plans do have a shorter shelf life than other traditional contribution plans. The maximum an employee can earn from a cash balance plan over the plan’s lifetime is approximately $2.9 million, which typically happens over the course of 10 years. Advisors may purposely design the plan so that an employee hits the limit after 10 years, allowing the company to retain that talent longer. 

4. Advisors must stay on their toes. 

Because the employer is responsible for shortfalls, it bears the risk of investment returns. Falling short of the required interest crediting rate, typically a 4% to 5% return, poses a liability to the employer, while too much return may negatively affect the company’s tax-deductible contributions and even lead to excise taxes. Advisors must go into cash balance engagements with the understanding that this is a fixed-income investment strategy, so they should monitor the plan’s assets and their relation to the plan’s accrued assets.

5. Implementing a cash balance plan has never been easier. 

The passage of the 2019 SECURE Act enhanced cash balance plans with the ability to establish a plan for the prior year, up until the company’s tax filing deadline. This new feature allows companies to begin receiving tax deductions for a year that has already passed. At the time of implementation, all qualified retirement plans must be intended to be permanent, and we recommend maintaining a plan for at least five years to satisfy this permanency requirement. Cash balance plans should not be used to make large contributions for a year or two before terminating the plan. They are a three-year commitment with the ability to amend contribution levels or freeze benefits along the way, but are not discretionary on an annual basis. 

Cash balance plans as flexible, dependable options

Cash balance plans are increasingly pushing traditional defined benefit plans to the sidelines, offering a more flexible and dependable opportunity for successful companies to significantly increase tax-deductible contributions and accelerating retirement savings for owners and exceptional employees.

As advisors, we have a responsibility to our clients to ensure that the implementation of such plans is not only seamless, but also propels their companies forward and positions them as employers that place high value on the talent they’ve fought to hire and retain. 

[1] “Data Shows Popularity of Cash Balance Plans,” Plan Sponsor (Dec. 28, 2021).

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Jerry Cicalese, CPC, QPA, QKC, CPFA, TGPC, AIF^®, is senior vice president of strategic partnerships for Sentinel Benefits & Financial Group. With offices in Massachusetts, Michigan, and New York, the company serves more than 3,500 clients across the U.S.

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