Planning Your Financial Future
Understanding Your Cash Balance Plan

The Basics

A cash balance plan is simple; the plan accumulates a cash value for every year of employment. Your employer adds two “credits” to the account each year. The first is a pay credit – a fixed percentage of your salary or a specified dollar value. The second is an interest credit – a fixed or variable rate of return on your account value. You get two credits once a year, every year. The plan is provided to you at no additional costs. As soon as you become an eligible employee, your company begins funding a cash balance plan. These are the basics, but, as you’ll see, the benefits are substantial. The value of a cash balance plan cannot be understated, especially for those with partial firm ownership.

Income Deferral

Attorneys owning part of a firm have the ability to defer a substantial amount of their paycheck to the cash balance plan each year. A cash balance plan falls under the definition of a defined benefit plan, not a defined contribution plan. A defined contribution plan limits how much can go into a 401(k) each year, $53,000 a year for 2016 ($59,000 if age 50+). A defined benefit plan only limits your potential yearly benefit in retirement, $210,000 a year in 2016. In other words, you are only limited in the amount you defer when your account can provide $210,000 a year benefit in retirement. This is a huge advantage! If your employer offers a 401(k) or 401(k) plus profit sharing, your retirement savings could be even more. To illustrate this point, take a look at the examples below for a 55 year-old equity partner (2016)1:

Example 1 – 401(k) plus profit sharing

  • Maximum pre-tax deferral: $24,000
  • Maximum profit sharing contribution: $35,000
  • Total retirement savings: $59,000

Example 2 – Cash balance plan and 401(k) plus profit sharing

  • Maximum cash balance pre-tax deferral: $180,000
  • Maximum pre-tax deferral: $24,000
  • Maximum profit sharing contribution: $35,000
  • Total retirement savings: $239,000

 1Plan limits here

IRS Regulations

It is important to be aware of the IRS testing guidelines ensuring retirement plans don’t cater too much to highly compensated employees. You may not be able to put away as much as you see above because the more the partners put away for themselves, the more they must provide for non-partner employees. Everything will be predicated on your firm’s plan documents; check with your HR department to find out the plan specifics. Regardless, the illustration should give you an idea of how much additional benefit a cash balance plan can provide, especially for those with a stake in the firm.

Owners of the firm are required to keep the plan at a certain balance as mandated by the IRS. An actuary for the plan will provide the value the plan must maintain in order to meet IRS guidelines. Owners are responsible for adding additional dollars to meet the benefit promised by the aforementioned yearly credits (i.e. the plan must be able to payout the credits promised to employees).

Leaving the Firm or Retiring – Now What?

The annuity payout is the default option for cash balance plans. Annuities come in three basic forms: single-life, joint-and-survivor, and period-certain. If you decide to take an annuity payout, be sure to evaluate the pros and cons of the three options. Nearly all plans offer a lump sum rollover to an IRA or 401(k). Both rollovers are a non-taxable event. This portability is a huge advantage over traditional pensions that often require waiting until at least age 59 ½ before doing anything, regardless of employment status. Whether you are at retirement or changing firms, an IRA rollover is one of your options.

Understand Your Firm’s Plan

We encourage you to learn more about the specifics of your plan by checking in with your HR department. The terms of each cash balance plan often differ from firm to firm. For example, a cash balance plan requires eligible employees be vested in three years or less. It’s important to know these details before doing anything with your plan.

That’s it. Glassman Wealth is dedicated to educating partners on their finances and retirement benefits. If this summary leaves you with questions, give us a call, and we will fill in the blanks.