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However, higher PBGC premiums could slow these plans’ growing popularity
Growth is not a word generally associated with defined benefit pension plans, but cash balance plans have proved an exception to that rule.
Also called hybrid plans, cash balance plans combine some features of 401(k)-type defined contribution plans within a defined benefit framework. For instance, like a traditional pension, plan assets are pooled and invested collectively by the plan sponsor, and each participant has a hypothetical account. But like a 401(k), the payout at retirement, whether in the form of an annuity or a lump sum, is based on account size (a set of Department of Labor FAQs delves into the details of how cash balance plans work).
The number of cash balance plans continues to grow each year, while the number of traditional defined benefit plans has shrunk for the past few decades. “Cash balance plans are the only area of defined benefit plans where we see some interest,” said Bruce Cadenhead, chief actuary for Mercer, an HR consultancy and benefit plan administrator, in Dobbs Ferry, New York.
Indeed, cash balance plans have come into their own after spending many years in regulatory limbo:
• Since 2006, the year the Pension Protection Act (PPA) was passed, the number of cash balance plans has soared, with 9,624 cash balance plans launched since then, according to the
2015 National Cash Balance Research Report conducted by Encino, Calif., consulting firm Kravitz Inc.
• By comparison, in the 20 years between 1985 and 2005, only 1,925 cash balance plans were set up.
The reason for this is clear: The PPA
included some key regulations that provided the certainty necessary for plan sponsors to adopt cash balance plans in larger numbers.
This growth trend has continued. The latest available numbers, from 2013, show the highest increase (32 percent) in cash balance plans in years, according to the Kravitz survey, based on an analysis of the Forms 5500 that retirement plans are required to file with the IRS. The study also found that cash balance plans were approaching the $1 trillion asset benchmark with $952 billion in assets.
The Kravitz analysis projected that these plans were on pace to exceed the trillion-dollar benchmark in 2014. Even the ever-popular 401(k) plan does not approach the same growth level, with just a 3 percent increase in new plans.
This growth has captured the attention of regulators, who released another important set of
rules governing cash balance plans in 2014. These new regulations provide cash balance plan sponsors with more flexibility on a number of fronts. “Plan sponsors now have the ability to use multiple investment options within a cash balance plan,” said Dan Kravitz, president of Kravitz Inc. He pointed out that these options provide plan sponsors with leeway to design asset portfolios tied to plan demographics by choosing more-conservative investments for plans with older employees approaching retirement and moderate to aggressive investments for plans for a younger population.
“Profitable small businesses—especially professional services firms, law firms, specialty medical groups—are driving cash balance plan growth,” said Kravitz. “About half of cash balance plans are in companies with 10 or fewer employees, and 80 percent are in companies with 100 or fewer employees.”
Kravitz noted that most cash balance plans are designed to help business owners and other high-earners save for retirement and shelter more of their income from taxes. But like 401(k)s, cash balance plans undergo annual nondiscrimination testing requiring them to provide a certain portion of benefits each year to nonhighly compensated employees in order to keep their tax-deferred status.
“While there are large benefits for owners and executives, the IRS nondiscrimination testing requirements often require these businesses to double up on the amount of retirement benefits they provide for participating employees,” Kravitz said. “While the average 401(k) plan might offer an employer contribution equal to 2.8 percent of employees’ pay, cash balance plans are doubling that.”
In addition, the fact that plan sponsors control the plan’s investments is critical for employers that want to use these plans in workforce planning. That’s because cash balance plans avoid putting the responsibility on employees to make investment choices, thereby avoiding poor asset allocation choices that can adversely affect employees’ ability to retire, noted Cadenhead.
There is also growing interest among some public-sector employers to introduce cash balance plans for new or existing employees, or as an optional benefit. California, Texas and Nebraska have successfully introduced cash balance plans for at least some state workers, and Kansas and Kentucky are relatively new to the cash balance plan arena. Other states have run into problems with the transition: Louisiana passed legislation to establish a cash balance plan for certain state workers only to have the law overturned by the courts on constitutional grounds.
If there is any blight on the horizon for cash balance plans, it is the growing burden of required premiums to be paid to the federal Pension Benefit Guaranty Corporation (PBGC) by cash balance plans with more than 25 participants.
The Bipartisan Budget Act of 2015
significantly increased future premiums on a per-participant basis and for the variable premiums paid on unfunded assets:
• By 2019, PBGC premiums will be $80 per participant and $41 per $1,000 of unfunded vested benefits.
• For comparison purposes, PBGC premiums in 2007 were $31 per participant and $9 per $1,000 of unfunded vested benefits.
Not surprisingly, these premium increases have been met with disfavor among those involved in pension plan design and administration. “I see nothing positive about the increases,” said Cadenhead. “I don't think [the increases] help the PBGC because premiums are going up to the point where they are driving sponsors away from defined benefit plans.”
Time will tell whether these premiums will negatively impact cash balance plans’ popularity. However, the signs point to continued growth, particularly as regulatory guidance provides more flexibility for plan sponsors.
Joanne Sammer is a New Jersey-based business and financial writer.
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