Is a cash balance plan right for your company?

When it comes to company retirement plans, you have many options one of them being a Cash Balance Plan.

So many, in fact that it can be overwhelming to decide which is type of company retirement plan right for your business. After all, it is your company’s future you’re deciding on – and the future of your employees.

In this article, we’ll outline the details of cash-balance plans. We want to help you determine if this type of retirement plan is right for your company.

What is a Cash-Balance Plan?

A cash balance plan is a type of pension plan in which an employer credits a set percentage of your annual compensation to an account. This type of plan falls under the category of a defined-benefit plan.

This means that your plan’s funding requirements, limits and investment risk are all based on the requirements of a defined-benefit plan, and that changes in your portfolio will not impact the final benefits employees receive upon retirement or if they are terminated.

How are benefits determined with this plan?

For every year in which you participate,, the plan will credit an employee’s account with a pay credit. This pay credit is typically a percentage of the employee’s compensation, and includes an interest credit.

These credits calculations can be obtain by formulas within the plan. However, the pay credit can be based off of a flat percentage of the employee’s pay (which will be the same for all employees) or rates directly linked to their age and length of employment (which will vary from employee to employee).

The interest credit is similarly specified within the cash-balance plan. It can either be as a fixed rate or based on rates from a varied specified investment outside the plan. Just as with a traditional defined benefit plan, the employer would assume the investment risk in a cash benefit plan.

For example: if the plan comes with an interest credit of 5{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} annually but only earns 2{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439}, an employer would be obligated to contribute more money to the plan to compensate for the difference.

If the opposite occurs, and the return of investment exceeds your defined interest rate, an employer may contribute less to the cash balance plan, but employees will still be guaranteed their benefits. When an employee leaves your employment, the benefits he or she is supposed to receive will be paid out. Regardless, of the investment performance of the account.

When to withdraw funds from a Cash-Balance Plan…

This is perhaps one of the most critical components of this type of plan. Usually it is the one that most people are confused about. It’s important for you to know when your employees can collect benefits in order to eliminate confusion.

Typically, a cash-balance plan will pay out when an employee has reached a normal retirement age.

In the United States, the average age of retirement, according to a 2014 Gallup poll, is 62. Unfortunately, due to lack of preparedness, layoffs and health issues, many individuals are now retiring later. In certain cases, a cash-balance plan stipulates a normal retirement age under the age of 65.

So what do you do if your employees are at “normal” retirement age but aren’t in a spot where they’re prepared to cash out your plan?

Determining when to cash out is easier than you think. If an employee is ready to retire or happens to switch employers, they can cash out their account.

Cashing out isn’t an employee’s only option. A better plan for employees is to transfer their cash-balance amount into a tax-free account or an IRA account. In the long run, it won’t be a lot of money – much less, in fact, than a traditional defined benefits plan or a 401(k) – however, this gives them the security of continued retirement savings.

Are Cash-Balance Plans the best option for my business?

It’s important to remember that a cash-balance plan is just one of many company retirement options. It may not be right for every business.

This type of plan can be a catch-22, depending on how well your traditional pension plan or 401(k) has performed. If your employees are relying solely on a 401(k), the addition of a cash-balance plan may reduce their taxes and provide additional savings for their later years. For older individuals, this type of plan may be a great choice, as its contributions increase with age.

If – as an employer – you rely on a traditional pension plan, the addition of a cash-balance plan is mostly likely unnecessary. This is because traditional plans tend focus on employee’s final working years. Cash-balance benefits encompass all working years, including those when earnings are at their lowest.

The number one concern for business owners considering whether or not this type of plan is right for their company is cost: you want to prepare for our employee’s future, but you also have the financial future of your company to think about.

For small business owners offering 401(k) plans, the addition of this type of pension plan can substantially increase your employee’s retirement savings, but may be more costly to you. As a business owner, you can expect to contribute roughly 5{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} to 8{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} of pay to a cash-benefit plan, rather than the traditional 3{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} associated with a 401(k) plan.