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The Right Way to Sell a Cash Balance Plan

The cash balance industry is booming — in fact, it’s growing faster than the 401(k) industry. In “The Right Way to Sell a Cash Balance Plan,” a column by Max Wyman that appeared in the Summer 2015 issue of Plan Consultant, Wyman discusses what cash balance plans are and how they operate.

But cash balance plans are not an automatic panacea. They are a “lean, mean tax-saving machine”, Wyman writes — that is, when they work. When they don’t, he says, “the sponsor is beyond frustrated, and this boils over to all other parties involved.” He argues that the best way to prevent that from happening is to ensure that during the sales process one makes sure that basic concepts about them are understood.

Cash balance plans provide monthly benefits at retirement that are the actuarial equivalent of a hypothetical account balance. The hypothetical account balance is the sum of pay and interest credits that are added to the beginning hypothetical account balance each year. Both of these must be defined in the plan document, Wyman states.

Cash balance plans normally require that they pass a number of tests that have to be performed annually, Wyman says. Like any defined benefit plan, he notes, they have to be tested to see if an adequate number of participants have received “meaningful benefits.” Cash balance plans also must pass non-discrimination testing.

But how the cash balance plan’s assets are invested may be even more important than the testing. The crucial determination is whether the plan’s investment policy and the market will provide investment returns sufficient to cover the interest crediting rate. An additional question: how is the cost of the plan to be allocated?

Wyman points out that cash balance plans are not profit sharing plans. Contributions are determined by an actuary and create an annual funding obligation to the plan. Current funding methods develop a wide range of allowable contributions after the first few years, he writes, but a minimum contribution will have to be made in order to avoid excise tax penalties. In addition, he notes, if the pension program involves a combination of a cash balance plan with a defined contribution plan (for instance, a profit sharing or 401(k) plan), the employer’s contribution to the DC plan is no longer totally discretionary.

But the funding obligation is not totally inflexible, Wyman cautions. Some methods of defining the pay credit will automatically adapt to lower compensation numbers in small plans, and if a bad investment year occurs before establishing a cushion, it might be possible to amend the plan for the current year to reduce pay credits if participants have not worked the requisite number of hours.

Wyman adds an important caveat, noting that “Just because demographically a cash balance plan makes sense doesn’t necessarily mean it’s ultimately the best option. He suggests that consultation regarding whether it is be done as part of the sales process, and that if it is not, there could be negative consequences.