In 2016 (the most recent year for which we have data), the number of new cash balance plans surpassed industry projections to grow 16%. By comparison, new 401(k) plans only grew by 1% that year. (1) This is a continuing trend, as new cash balance plans grew 152% between 2010 and 2015. (2)
Why Are Cash Balance Plans Growing So Fast?
Why is it that cash balance plans went from making up 2.9% of all defined benefit plans in 2001 to comprising over 37% by 2016? (3) What is driving such impressive growth? The main cause is changes in government laws and regulations.
What opened the floodgates was the 2006 Pension Protection Act. It clarified the legality of cash balance plans, making small business owners much more comfortable with their use. In fact, 92% of cash balance plans are sponsored by companies with fewer than 100 employees and 57% have 10 or fewer employees. (4) More than three-quarters of today’s cash balance plans were started after the 2006 Pension Protection Act became law. (5) It was the catalyst that set off the growth spurt we are still seeing today.
That growth has also been spurred on by IRS regulations in 2010 and 2014, allowing for broader investment options in cash balance plans. The new regulations removed certain funding issues and made the plans much more flexible for employers. Perhaps the most impactful was the addition of the “actual rate of return” option. Now, the number of large plans using that option is 39%, up from 10% only five years ago. (6)
The Benefits Of Using A Cash Balance Plan
While laws and regulations opened the doors to cash balance plans, they would not be seeing such impressive growth if they didn’t offer significant benefits. To the plan sponsor, they offer stability. It is much easier to control and forecast costs for a cash balance plan than for a 401(k) plan. They are also safer from a fiduciary perspective. Because the employees are not choosing their own investments, there is less risk involved.
For retirement savers, cash balance plans decrease risk as well. There is no risk of unknowingly choosing poor investments, as the participants do not choose the investments themselves. There is also less market risk. As the current bull market rages on, now the longest in history, everyone knows that there is a downturn on the horizon. With a cash balance plan, participants don’t have to worry about losing half of their life savings when the markets turn. They grow at a fixed rate ranging from 2 to 5.5% or at a variable rate, often tied to the 30-year treasury rate.
Cash balance plans are also great for business owners getting a late start saving for retirement. Contribution limits increase with age, so older participants have more opportunity to save than they do with other types of retirement plans. In 2018, those over 60 years of age can contribute over $250,000, reaching a maximum of $329,000 for 70-year-olds. (7)
Who Are Cash Balance Plans Best Suited For?
Clearly, there are great benefits to be had with a cash balance plan. But the rewards are not the same for everyone. Cash balance plans are most useful for business owners nearing retirement that make over $200,000 a year. Traditionally, owners and partners in professional groups, such as medical, dental, and legal, have been the biggest users of cash balance plans. However, they are gaining in popularity across the business world, from retail to technology and manufacturing. Now, professional groups make up less than half of the cash balance plans in existence. (8)
If you have a client in a similar situation, a cash balance plan may be just what they need to get on track with their retirement savings. Send me an email at firstname.lastname@example.org and I can go over the advantages of this type of retirement plan and how it could be best utilized in their specific situation.
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.