Cash balance pension plans aren’t new, but they are gaining in popularity.

Companies that offer their employees a cash balance plan may benefit from cost-savings over a traditional pension plan, as well as significant tax savings versus a 401(k) or other defined contribution plan.

What Is a Cash Balance Plan?

A cash balance plan is a type of pension plan where an employer credits an employee participant’s account with a set percentage of his or her annual salary, plus an interest credit. This interest credit is typically tied to the interest rate of an outside index, such as the one-year U.S. Treasury Bill rate.

Cash balance plans are defined benefit (DB) plans, which means that employees are guaranteed a specific “defined” amount upon retirement.

Like any DB plan, a cash balance plan is subject to pension funding requirements and the company is ultimately responsible for ensuring the plan is funded.

These pensions typically start paying out around age 65, but could be as early as 55 depending on the company. Note that employees don’t invest any of their own money in the plan, and they typically have no input into the investing choices.

But unlike DB plans, cash balance plans do offer transparency; savers can actually keep track of their account balances.

Cash balance plans also differ from traditional pension plans because they offer the benefit of portability. If an employee leaves the company prior to retiring, the balance is portable and can be rolled over to an IRA, if desired.

Why a Cash Balance Plan?

Each year, a company makes contributions of a specified amount of earnings to each employee participant’s account. Employers who offer cash balance plans typically contribute 5-8% annually, which is generally higher than DB plan contributions.

These levels increase for older workers: The annual contribution limit for a 55-year-old is more than $274,000, and more than $336,000 for a 65-year-old.

Contributions are made by the company, and are a tax-deductible business expense. This means that business owners, professionals, and partners who themselves want to contribute amounts in excess of $50,000 annually, say for their own retirement, can do so easily.

Good Candidates for Cash Balance Plans

As with any pension plan, companies with stable cash flow and decent earnings are good candidates for offering cash balance plans. These organizations will generally be in a better position to fund plans over the long-term.

Companies that have regularly contributed annually to employee plans should also consider offering such plans.

As mentioned, business owners and professionals who got a later start on retirement savings can use cash balance plans as a means to rapidly accelerate savings, making up the time to eventually reach the lifetime maximum of $2.6 million per account.

Keep in mind that the large contribution limits for older business owners and professionals offer the reciprocal benefit of a potentially significant tax deduction.

Finally, a cash balance plan can also be used in combination with a 401(k) plan to help maximize their retirement savings.

Converting to a Cash Balance Plan

For all of the advantages of a cash balance plan, note that companies converting their traditional DB plan to a cash balance plan usually leave their employees with a lower benefit than before, due to the higher contribution requirements.

Contributing to such accounts each year instead of a fixed payout based on employees’ years of service is a potentially big cost savings to the employer.

Cash Balance Plans May Be the Perfect Client Solution

A cash balance plan is a great option to add to your toolkit of retirement solutions offerings; such plans may offer significant tax and cost savings when compared to other employee retirement benefit plans.

Be sure to discuss the pros and cons on this type of plan with any business owner or professional clients who are looking to ramp up their retirement plan contributions.

All contribution limits discussed herein are believed to be current at the time of writing, however, Vestwell Holdings, Inc. and its affiliates do not offer tax advice and this information is offered for educational purposes only.