The fastest growing type of retirement plan in the United States because it is often the best way for business owners to set aside more for their own retirement and help their employees’ future retirement with additional tax-deductible contributions.

A Cash Balance plan is a type of Defined Benefit Plan often called by the IRS a ‘Hybrid Plan’ because it has some characteristics of a defined contribution plan (like a Profit-Sharing Plan). A Cash Balance plan is a Defined Benefit Plan that defines the retirement benefit in terms that are more characteristic of a defined contribution plan. In other words, a Cash Balance plan defines the promised retirement benefit to each participant in terms of a stated account balance. A Cash Balance plan is a twist on the traditional Defined Benefit plan in that it often allows for more flexible contributions from year to year in terms of a minimum and maximum contribution. Like a traditional Defined Benefit plan, a Cash Balance plan provides participants with the option of a lifetime annuity. However, unlike other Defined Benefit plans, Cash Balance plans create an individual account value for each covered employee, complete with a specified lump sum.

Employees like this because they can readily understand their account values from year to year. Business owners like this because they can understand how much they will have at retirement. Also, their vested account balances are portable and can be rolled into an IRA upon termination or retirement. Since all contributions made into the plan are made by the employer, the account balances are pre-tax to the participant so taxes will be due when the account is cashed out.

How does it all work? An actuary must be hired because these plans are extremely complex, but well worth the effort if the goal(s) of the business owner/employer can be accomplished. In a Cash Balance plan each participant has a ‘hypothetical account balance’ that is maintained by the plan actuary, who generates annual participant statements. Each participant’s account grows annually in two ways: 1) An employer contribution; and 2) an interest credit, which is guaranteed. A Cash Balance Plan has a recurring annual employer contribution which includes this guaranteed interest credit. The participant’s account balance, which is updated annually by the actuary, is backed by the existing plan assets. These plan assets are held: 1) within a ‘trust’ established by the Cash Balance plan document; and 2) in a pooled investment account. This means the plan assets of a Cash Balance plan are not individually directed by the participant. Instead, all plan assets and contributions are ‘trustee’ directed and approved. The plan assets are primarily invested in conservative instruments such as bonds and other non-equity securities. Each year, the Plan's actuary measures the plan assets in the trust and the average rate of return of the investments against the actuarial value of the theoretical account balances of all participants. This is done through a series of compliance tests and reports culminating in the filing of the Form 5500.

Note: To assure a successful Cash Balance plan, the plan actuary should be coordinating the Plan's actuarial assumptions with the Plan's investment financial advisor. The actuary should also make recommendations for current or future investment earning adjustments as needed. This is a very disciplined environment where much importance is placed on predictability and structure – so it takes a strategic team approach.

At its core, a Cash Balance Plan is different from your parent’s pension plan. It is without many of the problems previous Defined Benefit Plans have experienced. It is also an effective strategic tool for many businesses to allow the owners/shareholders/partners to catch up on retirement plan savings while reducing their overall tax burden. It is also an alternative to buying more unneeded equipment for tax deduction purposes. The key is forming a strategic communication team: owner/employer sponsoring the plan, financial advisor, CPA and plan actuary. This team should discuss plan needs at least once a year to determine: any future business changes that would affect the nature of the Cash Balance plan; if the plan is accomplishing the goal of the plan sponsor and if not, how it can be adjusted; and if the plan needs to be amended or frozen to assure the integrity of contributions.