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What are the benefits of a Cash Balance pension?

What are the benefits of a Cash Balance pension?

| September 22, 2019

There are many different options that allow you to save for retirement from traditional pension plans to defined contribution plans such as a 401(k), IRA’s and so forth. However, if you are a high earning individual such as a doctor, lawyer, or small business owner there is another option that you might want to consider. A cash balance pension plan can allow high earners to sock away large amounts of money for retirement while at the same time reducing your current tax liability, a classic “win-win” scenario. So how does it work? The cash balance plan allows you to credit a set percentage of your yearly compensation plus interest to a special account which your employer (or you if you are the business owner) owns. This is a type of defined-benefit plan and the plans investments, funding requirements, and degree of risk are all based on this fact. The company bears all ownership of profits and losses in the portfolio since it is based on defined-benefit requirements. At Innovative Financial Group Atlanta we are experienced and eager to assist you in learning more about this pension option, so let's take a look at how it all works. 

Classic vs Cash Balance

In contrast to a classic defined benefit plan the cash balance pension is maintained on an individual basis in the same way a defined contribution plan is. Many companies started moving towards this model to get rid of their classic, and expensive, traditional pension plans. The cash balance plan is also like a defined contribution plan because changes in the value of your portfolio don’t affect the yearly contribution. Investments are managed professionally and as with a traditional pension; participants are promised a certain monthly benefit on retirement. Many older business owners and those in high paying professions use the cash balance plan to accelerate their retirement savings. Those individuals aged 60 and over can put away well in excess of $200,000 annually in pretax contributions. By contrast 401(k) contributions for those 50 and older are limited to $57, 500.

While it is typical for a 401(k) contribution to be in around 3 percent of annual income the contributions for cash balance plans are typically much higher, in the 5 to 8 percent range. Participant accounts receive an annual “interest credit” which may be a fixed rate or variable such as one tied to the 30-year treasury rate. Once retired participants can take an annuity based on their account balance or a lump sum which can be rolled into an IRA or another employer’s plan. From the perspective of the employer these plans can be expensive because an actuary must certify each year that the plan is properly funded. However, if you are self-employed or the business owner this is less of an issue since you are essentially setting aside money for yourself. In the event plan performance falls below the actuarial recommendation you will be required to put additional money into the plan to make up any deficit, so it is important to always maintain adequate reserves. Typical costs to set up the plan include setup fees of $2,000 to $5,000, $2,000 to $10,000 in annual administrative fees, and investment managements costs that usually range from 0.25 to 1 percent of assets.

How Do You Begin A Cash Balance Plan?

Setting up and managing a cash balance pension plan is somewhat complex. Therefore, you will want an experienced financial advisor on your team to help you navigate the complexities and to help make sure your plan maximizes both retirement income and immediate tax savings. Innovative Financial Group Atlanta can be that advisor.  We can assist you in determining if a cash balance pension is the appropriate step for your situation.