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Facing retirement and cost of living crises, many Americans want to save as much as possible for the future. However, the IRS contribution limits in 401(k) plans make it difficult for high-earning employees to stash enough money away without tax consequences. Thankfully, there is another option. Cash balance plans offer more flexibility, higher contribution limits and a predictable annual expense for employers — making them an increasingly popular choice for many businesses, particularly professional service firms.
What is a cash balance plan?
A cash balance plan is a hybrid of defined benefit (DB) and defined contribution (DC) retirement programs in which the contribution and subsequent investment earnings are credited to participants. The fact that the overall value of the benefit is defined as an account rather than an annuity payable at retirement distinguishes cash balance plans from DB and DC programs, according to October Three partner John Kleiser.
Because it's delivered as an account and looks like a bank account, participants know how much money is in there. It also grows yearly by adding cash balance credits or contributions and then through interest credits. This transparency distinguishes it from annuities, where participants do not know the exact value.
Higher contribution limits
In a 401(k) account, participants can only elect to defer $22,500, or $30,000 for those aged 50 or older, a low percentage of income for high earners. The 401(k) limits are too restrictive compared to their total pay. They need a solution that will allow them to catch up on their retirement savings and save on tax deductions.
The inherent flexibility of cash balance plans allows participants and plan sponsors to choose the savings amount that works best for the participants, lowering their tax burden and increasing savings.
"Cash balance plans are used as an enhancement vehicle for professional service firms, such as medical practice groups, trying to attract and retain key employees," Kleiser told Broadcast Retirement News (BRN). "As an employer, if I can give somebody some more tax advantageous compensation elements as part of their overall package, that becomes a very, very attractive feature. Whether it's the partners at a law firm or the physicians in a medical practice group, offering those individuals an opportunity for additional tax deferrals is a competitive advantage."
Growing popularity and revenue benefits
Over the past decade, more professional service providers have adopted cash balance plans because they see them as an excellent way to attract and retain key employees. When competition is fierce for top performers, firms must set themselves apart from rivals.
But gaining an edge in recruiting isn't the only benefit of cash balance plans; year-to-year contributions are much more stable and predictable than traditional DB plans.
"What's nice about cash balance plans is you can set them up so that the contributions are much more predictable than in a traditional defined benefit plan because you're defining the benefit as a contribution credit, plus a rate of return that you choose," October Three partner Alex Kuhel told BRN. "You can budget your contributions based on how you design the program. And in a DB plan, you're subject to interest rate risk. Interest rates go down, you're not as funded, and your budget's thrown off. So, it's a much more budget-friendly program for a CFO."
Designing a sustainable cash balance plan
If you’re a firm interested in attracting top job candidates, it’s time to seriously consider implementing a cash balance plan for all or select employees. There are a few things to keep in mind while starting the process.
Building sustainability for years to come is imperative when designing cash balance plans. Since it's technically a defined benefit plan, businesses need an actuarial firm to create it and act as an administration by tracking balances, providing distribution paperwork, keeping up with regulations, and completing the 5500 form for the IRS.
Since there is a lot of data and numbers to keep track of, finding an actuarial consulting firm that can act as the plan designer and administrator/recordkeeper is essential for a seamless retirement solution for your company.
Contact one of our October Three expert actuaries today for a free design and administration consultation.