Even as 401(k) plan use is surging, there is another retirement option that is growing nearly 10 times as fast. What is this other option that is taking over the defined-benefit plan space and putting 401(k) growth to shame? Cash Balance Plans.
What Is A Cash Balance Plan?
A Cash Balance Plan (CBP) is a type of defined-benefit retirement plan. In this kind of plan, each employee has their own account, and their employer credits their account with a “pay credit,” or a set percentage of yearly compensation, and an “interest credit,” which is a predetermined rate.
Cash Balance Plans are often misunderstood to be defined-contribution plans because of the way the benefits are stated in terms of an account balance. However, no matter what happens with the underlying investments, employers are required to provide employees with the promised benefit, as with any other defined-benefit plan.
Cash Balance Plan Growth Over The Last 15 Years1
Among the approximately 700,000 retirement plans out there, over 15,000 of them are CBPs2. That may only make up a small percentage, but if you consider the fact that in 2006 there were only 3,893 CBPs, they have been growing at an impressive rate of 19%.
In 2006 the Pension Protection Act was passed, which helped clear the way for this remarkable growth by clarifying the legality of the plans and simplifying implementation and administration. Another boost to their popularity came in 2010 with new IRS Cash Balance regulations. The new regulations clarified things even further while adding more options that appeal to employers, such as expanded investment options. They also garnered significant media attention, which led to national awareness of the benefits of the plans.
Since then, CBPs have dramatically outpaced the growth of 401(k) plans, which have seen 2% growth. While in 2001 they only made up 2.9% of all defined-benefit plans, growing 1,035%, they now make up a noteworthy 29%.
Factors Contributing To Growth In Cash Balance Plans
Why have CBPs become so popular? As mentioned above, the Pension Protection Act and the new IRS regulations of 2010 helped make them easier to implement and more well known. Still, there are several more factors that have contributed to their meteoric rise among retirement plans.
The continual increase in federal, state and local tax rates have driven many business owners to be more strategic about tax planning. CBPs provide them with an opportunity to maximize tax-deferred retirement savings and also receive tax deductions for contributing to employee retirement accounts.
Appealing Plan Characteristics
CBPs are considered “hybrid” plans because of the way they combine the high contribution limits of traditional defined-benefit plans with the portability and flexibility of 401(k) plans. This is very appealing to many plan sponsors. CBPs are also seen as a way to sidestep many common risk factors and runaway costs characteristic of traditional defined-benefit plans.
Insufficient Retirement Savings
As the Baby Boomer generation nears retirement, many of them are realizing that they have inadequate retirement savings. Older business owners have found CBPs to be an excellent way to accelerate savings and maximize qualified plan contributions. Depending on age and compensation, the annual contribution to a CBP could be more than 4 times the maximum allowed with a 401(k) and profit sharing plan.
How We Can Help
There are many reasons that business owners are falling in love with CBPs. Perhaps you think that some of the reasons for their popularity listed above will resonate with your clients. If you think a Cash Benefit Plan might be a good fit for your clients, give me a call at 480.494.8992 or email email@example.com. I am a retirement plan specialist and I can answer any questions you may have about them.
About Kenny Phan
Kenny Phan is a Managing Partner at FinancialFocus Retirement Plan Services, a 3(16) fiduciary. He works as a pension specialist who partners with financial professionals to design and implement pension plans. His area of expertise is customized defined benefit, defined contribution, and 401(k) plans. Serving financial advisors and businesses in the greater Phoenix area, he is supported by FinancialFocus Retirement Plan Services. Together, they provide comprehensive plan design consultation, administration, document installation, compliance testing, as well as IRS and DOL reporting for qualified retirement plans.