Are Cash Balance Pension Plans a Good Retirement Option for Your Company to Offer?

Figuring out which type of retirement plan to offer your employees is not as simple as choosing a 401(k) and calling it a day. In fact, a traditional 401(k) is hardly the only option out there — and may not be the best choice for your company.

Depending on your business situation, a cash balance pension plan — also commonly called cash balance plans — could be a great option to consider.

What are cash balance pension plans?

Cash balance pension plans are a type of pension plan with a defined benefit to eligible employees at retirement. Funded entirely by the employer, the account is credited each year with a “pay credit” from the employer and an “interest credit” (at either a fixed or variable rate).

For example, a company may set up the plan so that employees receive 3% of their salary with a 2% interest credit. If an employee makes $100,000 annually, they would receive  a $3,000 pay credit, plus 2% interest paid on the account balance. As the employee remains with the company for several years, the account balance grows to meet the promised retirement benefit.

And unlike a defined benefit plan, which generally calculates an employee’s pension based on the last few years of highest compensation, a cash balance pension plan uses the total number of an employee’s years with the company to calculate the benefit.

Who are cash balance pension plans for?

While a potential option for any company (regardless of industry), cash balance pension plans are popular among professional service firms, like doctors and lawyers.

If the following statements are true for your company, this plan may be right for you:

• You have high cash flow.
• You are able to contribute at least 5% – 7.5% of your employees’ salaries annually.
• You face large tax liabilities.
• You have many employees who are in the top tax brackets and have large retirement savings goals.
• You want to attract and reward key or long-tenured employees.

Let’s cover the pros and cons of cash balance pension plans so you can compare them against other retirement plans to decide if it’s the best option for your company.

What are the benefits of cash balance pension plans?

Below are the biggest benefits that cash balance pension plans offer employers:

Annual contributions are flexible

Employers tend to favor cash balance pension plans because of the flexibility with annual contributions. While the plan guarantees an account balance at the end of an employee’s retirement, there is not a set annual contribution required from the employer. That gives the employer some flexibility in meeting the promised account balance. So if a fund’s investment gains were to earn a rate of return equal to or greater than the final balance promised to employees, an employee’s retirement fund could become fully funded without additional employer contributions.

Additionally, as an employer, you can make much higher contributions to this type of plan, compared to what’s permitted under a 401(k) or profit sharing plan. This is an ideal benefit for attracting and retaining high-earning talent.

You can greatly reduce your tax liability

Cash balance plans are qualified plans, which means you can deduct every dollar you put into the plan. Because you’re dealing with larger sums, this can mean a significant reduction in your company’s tax liability.

There is better protection against inflation

The U.S. Bureau of Labor Statistics points out an additional employer benefit: “But cash balance plans may not subject employers to the same degree of risk of pre-retirement inflation that can occur with terminal earnings formulas. Benefits are expressed in terms of a lump-sum payment, and at any point in time the employer knows the value of an individual’s account. Large wage increases just prior to retirement must be funded, but they do not have the same influence on employees’ final benefits that they would in traditional defined benefit plans.”

What are the drawbacks of cash balance pension plans?

Cash balance pension plans are great, but they aren’t a fit for every company. Here are some of the biggest drawbacks:

They’re not a good short-term option

Cash balance pension plans are considered “permanent” plans. This is a bit of a misnomer because the IRS doesn’t actually require you to keep these plans in place forever, but you do have to keep them active for at least several years. For it to make sense, you want to make sure you are confident in business longevity with consistently high revenue.

They’re less flexible than 401(k) plans

Cash balance pension plans require large contributions year after year. This means there’s very little flexibility for circumstances that may arise. For example, if you offer employees a 401(k) plan and you have unexpected financial issues come up, you can simply contribute less to the plan. But with a cash balance pension plan, you’re required to make your contribution regardless of your company’s financial performance.