The Cash Balance Plan: A Qualified Plan Opportunity for Advisors

Posted by John Peters, CFP, AIF

April 21, 2015 at 10:00 AM

qualified plan opportunity for advisorsWhat if I told you there's a qualified plan optimized for wealth managers who work with business owners? Well, there is! It's a cash balance plan, and it's growing in popularity among small and midsize businesses.

Let's examine how the growing interest in cash balance plans may provide a great opportunity for advisors and their business owner clients.

Why the Surge?

Kravitz, Inc., reports (via that "cash balance plans now make up 25% of all defined benefit (DB) retirement plans, up from only 2.9% in 2001." Why the surge?

  • Rising taxes
  • High contribution limits
  • Dearth of retirement savings
  • A means to increase business owner and employee retirement savings

So, is it time to consider how exploring this aspect of the qualified plan market could help your business—and your business owner clients? A good start is understanding what a cash balance plan is.

Defining the Cash Balance Plan

This type of defined benefit plan resembles the combination of a traditional pension plan and a pooled profit-sharing plan. Rather than defining an employee's benefit as a series of monthly payments made in retirement (e.g., 60 percent of the employee's highest three years of compensation), the cash balance plan defines the benefit as a stated account balance.

A participant's account grows in two ways:

  1. Annual company contribution. The employer contributes a percentage of pay or a flat dollar amount to the participant's account.
  2. Annual interest credit. For most cash balance plans, the assumed rate of return is based on the 30-year Treasury bond. This rate changes annually, but a 4-percent interest credit has been typical in recent years.

These qualified plans enjoy IRS tax-favored status and were formally recognized by the Pension Protection Act of 2006. Moreover, tax advisors generally agree that these plans should be funded to their maximum before exploring other tax-efficient strategies.

Cash Balance Plan Q&A

Sound interesting? Indeed. Here's what you should know before recommending these plans to your clients.

Who manages the assets? Investments are managed by the employer or financial advisor, not by plan participants. Because employees can't direct their investments, you can manage the assets on your firm's platform. This makes it a potentially ideal product for a wealth management-focused advisor. Keep in mind, though, that to provide investment advisory services to a qualified plan, your firm may require that you hold a designation, such as the Accredited Investment Fiduciary® or other similar credential.

How much can be contributed to a typical plan? Annual contributions are age dependent—the older the participant (or business owner), the higher the allowed contributions. Why? An older person has fewer years to save toward the approximate $2.6 million lump sum allowed. (Note that contributions are subject to IRS limits and are determined by a formula specified in the plan document.)

How will your assets under management be affected? To provide a comparison, a $1 million IRA will generally provide a one-time increase to your assets under management. Since a cash balance plan is funded annually and over a number of years, however, this funding may have a significant impact on your assets under management and revenue year after year.

What are the distribution options upon retirement or employment termination? Plan balances are portable. Business owners may try fully funding their cash balance plans until they retire or sell their businesses. Upon retirement, they can roll over account balances to IRAs or other qualified retirement plans. (Proceeds can also be paid as annuities or lump-sum distributions.)

Can cash balance plans be offered in addition to 401(k) or other plans? Yes, employers can offer a combination of qualified retirement plans, producing larger contribution amounts. A 401(k) in combination with a cash balance plan may be ideal for many companies and partnerships.

Must everyone participate equally? No, employers can contribute different amounts for each participant (a percentage of pay or a flat dollar amount). For example, business owners can target contributions to themselves or key executives whom they want to retain or incentivize.

What about tax savings? Implementing and funding a cash balance plan could substantially increase tax-deductible contributions, resulting in significant tax savings to participants. Cash balance contributions could reduce both taxable income and adjusted gross income, so high-income earners may move into a lower tax bracket. With increased taxes and new taxes implemented at the federal, state, and local tax levels, tax savings from contributions into cash balance plans and subsequent earnings can be significant.

Are plan assets protected from creditors? Yes, cash balance plan assets (and all other qualified plan assets) are protected from creditors in case of bankruptcy. Business owners and partners may move assets from their businesses to the plans—where the assets are shielded from creditors and can be used as retirement nest eggs or passed on to heirs.

The "Ideal" Client?

Both employers and employees may benefit from these plans, including:

  1. Business partners or owners who want to contribute more than $50,000 per year to their retirement accounts. Many professionals and entrepreneurs neglect personal retirement accounts while building their practices or companies and need to catch up on retirement savings. Acceleration of savings is allowed, with possible pretax contributions from $100,000 to $240,000 annually, based on an individual's age.
  2. Companies already contributing to employees' retirement savings or willing to do so. These plans are often established for key executives and highly compensated employees but are also suitable for others. A cash balance plan typically provides a minimum company contribution of 3 percent to 4 percent for staff, on top of 5 percent to 7.5 percent of pay in a separate 401(k) profit-sharing plan.
  3. Companies with consistent profit patterns. Because a cash balance plan is a pension plan with required employer contributions, consistent cash flow and profits are essential.

Advisor Benefits

We've covered how these plans work. Now, let's examine how they might work for you:

  • With a higher contribution threshold than a 401(k), a cash balance plan can significantly affect your assets under management and perhaps your payout at your firm.
  • Time and energy can be devoted to working with business owners and other executives, with limited interaction with plan participants, since participants don't manage their own accounts.
  • Your clients can catch up on retirement savings—potentially contributing 10 years of savings in 3–5 years.
  • This plan may be an effective tax planning tool. Business owners may move assets from the business to the plan, shielding assets from creditors and helping save on federal and state income taxes. This can lead to more assets for you to oversee.

Seize the Opportunity

With a growing interest in cash balance plans, they could provide entrée into the qualified retirement plan market in a way that is manageable for your practice, as well as offer a chance to grow your business. Are you ready to seize the opportunity?

Have you seen increased interest in cash balance plans among your clients? Have you taken advantage of this or any other qualified plan opportunity for advisors? Please share your thoughts with us below.

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Topics: Retirement Consulting

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