As we’ve mentioned in previous posts, there has been a lot of press this year about cash balance plans and how they can provide great retirement deferral opportunities for certain types of plan sponsors: law firms, physicians groups, and small employers. However, there is the occasional case of buyer’s remorse with these plans so I thought that I’d point out some indicators of when someone may not be a good candidate for a cash balance plan.
1. Unpredictable cash flow: Cash balance pension plans generally require annual contribution that are mandated by the IRS. If your business doesn’t have a predictable cash flow, then a profit sharing plan might be a better option (though it has lower deduction limits).
2. You haven’t maximized your 401(k)/profit sharing deferrals yet: Business owners looking for retirement savings deductions should start with a 401(k) or profit sharing plan. These plans provide the opportunity for combined deductions of around $49,000 per owner per year (plus catch-up contributions). If you are already deferring the maximum amount into these plans and want to defer significantly more, then a cash balance plan might be a good fit.
3. You don’t want to give additional benefits to your employees: Sponsoring a cash balance plan that has high deductions for owners generally requires that employees receive a total allocation (401(k) plus profit sharing plus cash balance pay credit) of 7.5% of pay per year. If you are already giving employees a retirement allocation of 6.0% of pay per year, then the additional 1.5% may not be a big deal. Otherwise, you’ll want to make sure that your personal deductions will be large enough to justify the added benefits expense.
4. You want to take your money out of the plan right away: The IRS requires that cash balance plans have “permanence”, and one rule of thumb is that this means they must be around for at least 5 years before they are terminated and assets rolled over.
5. You don’t want to pay any fees to maintain a plan: As with any qualified retirement plan (pension or 401(k) plan) there are certain fees associated with sponsoring a cash balance pension plan. There are start-up costs to design and implement the plan, maintenance costs each year, and tail-end costs when the plan is terminated. These expenses are relatively fixed each year, so you want to make sure that you are maximizing your deferral opportunities in order to justify the expenses.
The items above aren’t meant to scare you away from cash balance plans, but rather are meant to address some common criticisms. For many businesses, a properly designed cash balance plan can provide huge tax deduction opportunities and be an integral part of owners’ retirement planning. To see if a cash balance plan would make sense for you, it’s a good idea to consult with your financial planner and also to get a good plan design analysis from an actuary.