Maximize Employee Benefits and Realize a Greater Tax Deduction with a Cash Balance Plan
Small business owners can sometimes feel that they are being buried by challenges like cash flow, competition, and finding and retaining customers. But a key to many of those problems is similar to that last one: Finding and retaining valuable employees.
There are a number of ways of selecting the staff that is right for your business, but in these ever more competitive times offering an attractive benefits package can be crucial. One way to help key employees maximize their benefits – and for your business to realize a greater tax deduction as well – is a cash balance plan.
A cash balance plan is a defined benefit (or pension) plan with a hybrid structure that combines features of both defined contribution and traditional defined benefit pension plans. As with a traditional defined benefit plan, the employer in a cash balance plan determines benefit levels and is responsible for required plan contributions to fund the benefits. Funds are pooled and managed as a single trust fund.
Similar to a defined contribution plan, however, cash balance benefits are communicated to employees in terms of an account balance, rather than as a monthly income stream. Each participant has an account that grows annually based on employer contributions and interest credits that are guaranteed rather than dependent upon plan investment performance. The plan’s funding limits, funding requirements and investment risks are based on defined-benefit requirements; since changes in the plan’s portfolio do not affect the final benefits to be received by the participant upon retirement or termination, the company alone bears all ownership of profits and losses in the portfolio.
A cash balance plan’s assets are pooled and invested by the plan’s investment manager. If investment earnings exceed the guaranteed rate, the excess is used to offset future plan contributions; if investment earnings are less than the guaranteed rate, plan contributions will have to increase. Investment earnings do not affect the benefit amounts promised to participants — like a traditional defined benefit plan, cash balance benefits are guaranteed.
Annual contribution credits may be constant or may increase based on a given participant’s advancing age and/or years of service. The contributions are credited with a rate of interest that is typically tied to an outside index, such as the one-year U.S. Treasury Bill rate. A variety of investment vehicles may be used to achieve the annual interest crediting rate.
On an annual basis, participants receive a statement illustrating their account balance, which equals the lump sum value of their benefits under the plan. Statements include a beginning-of-year account balance, earnings for the year, the employer contributions and an end-of-year balance.
As in a defined contribution plan, cash balance benefits can be distributed as a lump sum payout upon termination at any age. This gives the cash balance plan the advantage of having completely portable benefits. And since they are defined benefit plans, the benefits promised by cash balance plans are generally protected, within certain limitations, by federal insurance provided by the Pension Benefit Guaranty Corporation (PBGC).
A cash balance plan can be an ideal solution for:
- Businesses with strong profit margins and a reliable earnings stream.
- Closely held family businesses or corporations with fewer than 25 employees.
- Employers seeking to offer a plan with contribution limits over and above current defined contribution plan limits.
- Businesses looking for a larger tax deduction than a 401(k) or other defined contribution plan can offer on its own.
- Employers looking for greater plan design and contribution flexibility to provide different benefits for different employees.
In addition, other advantages include:
- Simplicity. Benefits are structured in a way that is easily communicated to employees. Employees are better able to appreciate the value of the plan since benefits are communicated in the form of a lump sum account balance, including employer provided allocations and investment earnings.
- Cost Control. Cash balance plans tend to reduce pension costs because benefit targets are based on current salary rather than projected final average salary. Employers typically find they can get “more for less” by providing a more easily understood and appreciated benefit at a lower cost.
- Flexibility. Plan features afford the employer maximum flexibility and can be designed to meet both cost and benefit objectives.
- Tax Implications. As with all qualified pension plans, contributions are fully tax-deductible to the organization and benefits accrue on a tax-deferred basis.
Small Business Week is an optimal time to further explore what a cash balance plan can do for you.
NOTE: Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Past performance is not a guarantee of future results.
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