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Advocates praise them, but hybrid retirement plans remain a niche offering
In many ways, cash balance pension plans suffer from guilt by association—but once employers learn that such plans have fewer liabilities than traditional pensions, they become more attractive.
Many employers have long shied away from traditional defined benefit pensions because of the associated regulatory burden, uncertain future funding requirements and rising premiums paid to the federal Pension Benefit Guaranty Corporation (PBGC).
Cash balance plans are technically classified as defined benefit plans, but these hybrids feature elements of both traditional pensions, including PBGC premiums (with
an exception for some smaller plans), and defined contribution plans, such as employee contributions. Significantly, their lack of a guaranteed payout amount combined with their high limits on tax-deductible funding are compelling to certain employers.
According to findings from the Society for Human Resource Management's (SHRM's)
2016 Employee Benefits survey of SHRM members and
earlier SHRM survey reports:
While the largest cash balance plans hold more than $50 billion in assets, 52 percent of plans hold less than $500,000 and 57 percent have fewer than 10 participants, according to the
2016 National Cash Balance Research Report compiled by pension consulting firm Kravitz Inc., based in Encino, Calif.
In other words, cash balance plans are more popular among smaller employers and less so among large employers. This could change, however, as companies continue to find that a 401(k) plan alone is insufficient to meet employees' retirement needs and subsequently add annuity options and automatic features to make 401(k) plans operate more like traditional pension plans.
There is a newer type of cash balance plan that benefit managers may want to consider, explained John Lowell, a consultant and actuary with October Three Consulting LLC in Chicago. Market-return cash balance (MRCB) plans were first authorized by the Pension Protection Act of 2006 but have yet to be embraced by employers in large numbers, he noted.
"Essentially, the difference between an MRCB and a traditional cash balance plan is in the interest credits," Lowell said. "An MRCB ties interest credits to some market-based return, such as the return on trust assets, while a traditional cash balance plan provides either a fixed rate of return or ties that rate of return to a known index such as 10-year Treasuries."
"If one high-profile company adopted an MRCB, other employers would be more likely to follow suit," Lowell said.
One of the reasons MRCBs in particular, and cash balance plans generally, haven't been more widely adopted is lack of information about these plans and how they work. By educating themselves on the pros and cons of these plans, HR and benefits executives can play an important part in helping other senior executives and business owners decide whether cash balance plans are worth another look.
"[A cash balance plan] could be a tool for providing better retirement benefits to employees while also providing significant tax savings to the business owner," said Dan Kravitz, president of Kravitz Inc.
[SHRM members-only toolkit:
Designing and Administering Defined Benefit Retirement Plans]
The Tax Advantage for Employers
Cash balance plans can be a boon to participating employees while also appealing to decision-makers. For highly profitable businesses, these plans offer owners, executives and employees tax-free retirement savings at a level that is much higher than what a 401(k) plan can offer, including age-weighted contribution limits for older participants. In many cases, "the motivation in offering a cash balance plan is to shield business profits from taxes," Kravitz said.
The tax savings can be compelling even though employers with a cash balance plan and a 401(k) plan tend to spend more on retirement benefits (6.5 percent of payroll) than employers that have only a 401(k) plan (3.1 percent of payroll), according to the Kravitz Inc. data.
Dan Kravitz noted that a cash balance vehicle could be cost-neutral or even cost-beneficial to the employer because any additional contributions on employees' behalf could be offset by the tax savings on the amount of that contribution. For example, "if the owner of a company with 10 employees contributes $100,000 to a cash balance plan—$50,000 for the owner and $50,000 for employees—the resulting $100,000 in tax deductions will offset the cost of making the employee contribution," he said.
For employers to realize the full tax advantages of offering a cash balance plan, they must pay taxes every year. In other words, they must have a consistent flow of annual profits. They should also evaluate the potential tax savings versus plan costs before deciding to establish a cash balance plan.
If business owners want to maximize their own retirement savings, particularly in their later years, cash balance plans' higher contribution limits can be particularly compelling. In some cases, these tax-deferred contributions could be in excess of $50,000 per year, according to Kravitz.
More-Consistent Benefit Spending
Fluctuating funding requirements is one of the key reasons many companies have turned away from traditional defined benefit pensions and embraced defined contribution plans like 401(k)s. Advocates for cash balance plans, in response, emphasize the more-predictable contributions that these plans offer. "Market-return cash balance plans, in particular, provide returns similar to those provided by a defined contribution plan," Lowell said.
Barring unusual fluctuations in the financial markets, Lowell predicts that employers would find an MRCB plan to require contributions that actually are more consistent than 401(k) plan matching contributions. "In 19 out of 20 years, plan contributions equal to 5 percent of pay might fluctuate by 0.1 or 0.2 percent at the most," he said. "That is pretty stable and something most organizations can handle."
By contrast, 401(k) plan matches will depend on how much employees decide to defer into their accounts each year, creating a less certain annual financial commitment on the part of employers who want to maintain a stable contribution match. Traditional pension plans, which guarantee a promised payout level despite underlying asset values, carry the most financial risk to employers by far.
Joanne Sammer is a New Jersey-based business and financial writer.
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