In corporate America, pension plans may be fading away. Only 14% of Fortune 500 companies offered them to full-time employees in 2019. In contrast, legal, medical, accounting, and engineering firms are keeping the spirit of the traditional pension plan alive by adopting cash balance plans.1
Owners and partners of these highly profitable businesses sometimes get a late start on retirement. Cash balance plans give them a chance to catch up since these defined benefit plans are age-weighted: the older you are, the more that can sock away each year, up to $336,000, depending on your age.2
How does a cash balance plan differ from a traditional pension plan? In a cash balance plan, a business or professional practice maintains an account for each employee with a hypothetical “balance” of pay credits (i.e., employer contributions) plus interest credits. The plan’s objective is to pay out a pension-style monthly income stream to the participant at retirement – either a set dollar amount or a percentage of compensation. Lump-sum payouts are also a choice. Another important factor to keep in mind is that cash balance plans are commonly portable: the vested portion of the account balance can be paid out if an employee leaves before a retirement date.3
An employer takes on responsibility with a cash balance plan. The plan document states that annual contributions must be made—either in the form of a percentage of pay or a lump sum. An actuary needs to advise the employer, and help the business determine the yearly contribution needed to appropriately fund the plan. The employer effectively assumes the investment risk, not the employee.3
Cash balance plans must cover at least 50 employees or 40% of the firm’s workforce, whichever is lesser. They can be used in tandem with 401(k) plans.4
Benefits are based on career average pay. In a traditional defined benefit plan, the eventual benefit is based on a 3- to 5-year average of peak employee compensation multiplied by years of service. In a cash balance plan, the benefit is determined using an average of all years of compensation.3
Cash balance plans can be less sensitive to interest rates than some pension plans. As rates rise and fall, liabilities in a traditional pension plan fluctuate. This may open the door to either overfunding or underfunding (and underfunding is a major risk right now with such low interest rates).
A cash balance plan cannot be administered with any degree of absentmindedness. It must pass yearly non-discrimination tests; it must be submitted for Internal Revenue Service approval every five years instead of every six. A plan document must be drawn up and periodically amended, and there are the usual annual reporting requirements.
Ideally, a cash balance plan is run by highly compensated employees (HCEs) of a firm who are within their prime earning years. In the ideal scenario for non-discrimination testing, the HCEs are 10-15 years older than half (or more) of the company’s workers.
If trouble occurs and a company flounders, cash balance plan participants have a degree of protection for their balances. Their benefits are insured up to their maximum value by the Pension Benefit Guaranty Corporation (PBGC). If a plan is terminated, plan participants can receive their balances as a lump sum or request periodic payments.
For additional insights and resources, be sure to sign up for our Weekly Market Commentary, follow our YouTube channel where we regularly post our Epic Market Minute videos, follow us on LinkedIn, or like us on Facebook. And as always, please don’t hesitate to reach out to a dedicated service professional at Epic Capital.
Recently, you may have seen reports that a record-low number of homes are available for sale—roughly 1.03 million nationwide. If you compare that to the average number of homes for sale during the past 10 years, it’s no surprise that many hopeful homebuyers are having issues securing a home. But why exactly is the housing … Continue reading “Forces Driving the Housing Market”
It can be exhausting trying to keep up with the whims of Wall Street. Lately, the financial markets have been fixated on federal taxes and what may be proposed on Capitol Hill in the weeks and months ahead. Wall Street’s focus on taxes closely follows its attention on the 10-year Treasury yield. And it wasn’t … Continue reading “The Whims of Wall Street”
President Joe Biden introduced the much-anticipated American Jobs Plan, which outlines an approach to spend roughly $2.2 trillion on the nation’s infrastructure and other projects. As part of the legislative process, the Biden administration also laid out a proposal for paying for the domestic investment. The plan includes raising the corporate tax rate to 28% … Continue reading “Paying for the Infrastructure Bill”
Financially, many of us associate the spring with taxes – but we should also associate December with important IRA deadlines. This year, like 2020, will see a few changes and distinctions. December 31, 2021, is the deadline to take your Required Minimum Distribution (RMD) from certain individual retirement accounts.
There’s an old Wall Street maxim that says, “markets climb a wall of worry.” And these days, there’s plenty to worry about with the trend in long-term interest rates and bonds.
Epic Capital provides the following comprehensive financial planning and investment management services: Learn More >