Plan Design in the Balance
Weighing the pros and cons of cash-balance plans.
Is your company interested in additional tax deductions and increased retirement savings? Does your company desire deductible contributions greater than the annual additional maximum per person of $49,000 for a defined contribution plan, at least for key personnel? If so, you should consider whether a cash balance plan is right for your company.
A cash balance plan is considered a defined benefit plan and must follow the rules relating to those plans. However, a cash balance plan looks like a defined contribution plan to the participant. A hypothetical account is maintained for each participant, the company makes annual notional contributions, and interest is credited on the account. The contribution to the account is either a flat dollar amount or a percentage of compensation. The interest credited is either a fixed rate (for example, five percent) or tied to an index, such as the 30-year Treasury bond rate. Like any defined benefit plan, benefits are based on the plan's formula and not on the actual investment earnings on plan assets. Actual investment earnings of the plan assets also do not affect the account balance. Thus, the company rather than the employee bears the investment risk. This is in contrast to a money purchase type of plan where there are actual individual accounts for which the plan sponsor must also make annual contributions. However, a money purchase plan is a defined contribution plan and the plan participant, not the plan sponsor, bears the investment risk.
As a defined benefit plan, annual actuarial valuations must be performed. The valuation determines the required minimum contribution and the maximum tax-deductible contribution. Since the contributions are determined actuarially recognizing actual asset values and future plan demographic experience, the required contribution will not match the sum of the contributions to the hypothetical participant accounts. An employer's required and deductible contributions will decrease if assets perform better than expected. Conversely, if assets perform worse than expected, employer contributions will increase. Assets are invested in a commingled account to provide benefits for all participants; no actual individual accounts are created. Participants, therefore, cannot direct the plan's investments.
This article has been excerpted from the Journal of Accountancy. Read the full article here.