PLANSPONSOR - May - June 2023 - 37

That also keeps business costs down as,
under a traditional plan, employee costs
rise as workers near retirement age.
FuturePlan's research shows the
greatest growth in cash balance plans to
be in small to midsize businesses with
100 or fewer employees-especially, in
the past seven years, with 25 or fewer.
Pension Benefit Guaranty Corporation
coverage and fees start once employee 26
has enrolled, says Steve Sansone, managing
director of the SageView Advisory Group
office in Valencia, California.
Often, one of these plans supplements
a 401(k) as an added way for participants
to save, income tax-deferred, beyond
the DC plan's
combined
employee/
employer contribution limit-for 2023,
$66,000. According to federal tax law,
high-income participants in the cash
balance plan could receive up to $300,000
in contributions on their behalf annually-up
to $3 million over their lifetime,
indexed to inflation.
The plans are popular with professional
service firms, such as those operated
by doctors, lawyers, investment
advisers or other professionals, where
much of their income is taxed as ordinary
income, Kravitz says.
Smith says a the type of earner who
profits from the tax-sheltering benefit is
one who earns $300,000 or more. If the
partnership or business owner cannot
afford to take advantage of the incometax
savings, " then there's no reason to
have one [of the plans], " Smith says.
The lure of a cash balance plan is
that high-earners can accelerate taxdeferred
savings, but, to open a plan, a
company must pass IRS discrimination
and coverage tests. To reap the biggest
such savings for
their high-earners, a
company must be able to contribute 5%
to 7.5% of employee compensation into a
profit sharing 401(k) that benefits all of its
employees, Sansone says.
" The owners are getting large deductions,
but the rank and file are getting
7.5% of pay. It's a very generous contribution, "
he says.
And, because these are Employee
Retirement Income Security Act plans,
they are sheltered from creditors in case
of bankruptcy or lawsuit, Cicalese says.
contributing more in a one-time payment
to cover the shortfall, Sansone says.
Making up any shortfall is necessary
because, if the plan runs into significant
Cash balance plans require
actuarial work and cross-testing,
making them about two to three
times more expensive than
a 401(k) plan design.
Points to Consider
Cash balance plans require actuarial
work and cross-testing, making them
about two to three times more expensive
than a 401(k) plan design, Sansone
says. Contributions must be made annually,
so the plans work only for firms that
are consistently profitable-able to make
the payments to all the employees; with
a 401(k), on the other hand, the sponsor
may easily freeze employer contributions.
Sansone says under certain circumstances
cash balance plans may be
frozen, though. He froze some in 2020,
after COVID-19 hit, since plan participants
had not reached 1,000 hours of
service for the year, which is one way to
legally freeze contributions.
The plans are also legally binding.
Kravitz says they must define the pay
credit, which can be a percentage of pay
or a fixed dollar amount, and specify
the guaranteed interest crediting rate.
He uses a 4% fixed crediting rate. For
example, a medical group with a shareholder
doctor may have a contribution
credit of $250,000, and the employees
receive a pay credit of 8%, plus a guaranteed
return of 4%.
Hitting the interest crediting rate
exactly every year is hard, so sometimes
plans can be slightly over- or underfunded.
If a plan is underfunded in a given year,
there are a few options the company may
use to bring it to full funding, including
deficits, this affects portability, Smith says.
More recently, some plans have
started using a variable crediting rate
instead of the fixed rate. Doing so allows
the plan to use the investment performance
of its assets for a particular year vs.
a fixed amount as the credit rate, Sansone
says. This helps address the occasional
underfunding. However, any shortfalls
that do occur must be trued up when a
participant leaves.
Since the costs to start and terminate
a plan are high, business owners should
plan to operate these plans for at least
three to five years to make them economical,
Sansone says.
There is no formal IRS rule stating
how long a cash balance plan must exist;
in the agency's view, the plans should
have some permanency.
Cicalese says that is why cash balance
plans are for well-established businesses
with a history and a pattern of earnings
to support contributions. He says his
firm designs these, expecting them to be
open for five years, while the maximum
benefit to the participant comes by year
10. The plans may be frozen, as noted
above, or amended if the benefits are too
rich; they may also be terminated, but
the IRS requires good reasons, he says.
" You need to go into this with the
mindset that I'm going to make at least
three years of required contributions, " he
says. -Debbie Carlson
PLANSPONSOR.COM May - June 2023 37
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