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Cash Balance Plans & Their Hits and Misses

Just because a Cash Balance Plan sense for a company demographically doesn’t mean it works all the time. But is sure is miles ahead of the old traditional Defined Benefit for flexibility.

Their Hits, when they work properly, cash balance plans develop tremendous tax-saving. When they don’t, the companies and participants can become confused, frustrated, and this affect everyone involved. The best way to prevent confusion and misunderstands is for the company and participants are clear on the following basic concepts.

Cash balance plans are not Defined Contribution plans! Contributions are not discretionary, but are determined by an actuary and the annual deposited to the plan on or before the filing of the companies tax return including extensions. Current funding methods develop a wide range of allowable contributions, but there will be a minimum amount of contribution required to fund the plan properly.

The contribution or pay credit can be designed to automatically adapt to lower compensation numbers. While using the maximum range of contribution level allowed to prefund or maintain a cushion (assets in excess of the account balances) will allow lower contributions in bad investment years without jeopardizing benefits.

Their Misses, these plans normally require that they pass a number of tests that have to be performed annually. Like any defined benefit plan, they have to be tested to see if an adequate number of participants have received “meaningful benefits.” Currently, 40% of eligible employees, or if less, 50 employees, must receive an allocation each plan year that converts to a monthly benefit at retirement equal to 0.5% of compensation.

Next, the plan must pass non-discrimination testing. This testing is very complicated. An oversimplification is that a small percentage of non-highly compensated employees (NHCE) must accrue monthly benefits, or receive current contributions, expressed as a percentage of pay equal or greater than each HCE (Highly Compensated Employees, i.e. owners).

Solution, incorporate a 401-k Profit Sharing Plan to increase contributions to HCE and help past testing for the NHCEs by combining the two plans.

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