Mid-market firms return to cash-balance pension plansReprints
At a time when stock-market volatility is causing retirement anxiety among aging baby boomers, cash-balance pension plans are becoming increasingly popular among middle-market and smaller employers, industry experts say.
Because cash balance plans are a type of defined benefit plan, they provide a guaranteed benefit regardless of how the underlying investments perform, unlike 401(k) plans whose value can fluctuate based on how the funds are invested. Cash balance plans also are insured by the Pension Benefit Guaranty Corp, while 401(k) plans are not.
Cash balance plans are especially attractive to professional service firms with large numbers of high-paid executives, experts say, because the amount that can be invested in them is significantly higher than the Internal Revenue Service allows for defined contribution plans.
While employees can contribute up to $17,000 annually to a defined contribution plan—or $22,500 if they are over 50—and an employer can match those contributions up to a total of $50,000, employers can fund an annual benefit of up to $200,000 per employee in cash balance or other defined benefit pension plans.
Since the stock market crash of 2008 and continuing volatility of 401(k) investments, middle-market business owners are increasingly turning to cash balance plans as a “safe money” option, according to Dan Kravitz, president of Los Angeles-based retirement plan administrator Kravitz Inc. Of the more than 1,000 retirement plans that Kravitz administers, approximately 400 are cash balance plans.
“We're seeing a lot of growth in the small and middle market,” Mr. Kravitz said.
Figures published by the PBGC for “hybrid plans,” which include cash balance plans, support this assertion. While just 681 of these plans were offered by employers with fewer than 1,000 participants in 2001, the number grew to 2,865 in 2009, according to PBGC data.
Overall, the number of cash balance plans grew 21% nationwide between 2009 and 2010, almost double the previous year's growth rate of 11%, according to Kravitz's 2012 National Cash Balance Research Report.
At the same time, the number of new 401(k) plans shrank slightly during the same period, down 1%, Kravitz reported.
Cash balance plans are especially popular among “law firms, multispecialty medical practices and accounting firms looking to increase the amount they can put into a retirement plan for themselves, their partners and employees,” Mr. Kravitz said.
With cash balance plans, “they can save more than the IRS allows for 401(k) plans,” he said.
For example, it is possible to put away up to $250,000 when a 401(k) and cash balance plan are offered together, Mr. Kravitz said.
In fact, the vast majority of employers introducing new cash balance plans already offer some type of defined contribution plan to employees, according to Sheldon Gamzon, a principal at Pricewaterhouse Coopers L.L.P. in New York.
“Nearly everyone has a 401(k) plan already,” Mr. Gamzon said. “Cash balance plans are often being added as supplemental.”
The business tax savings is also a significant motivating factor behind businesses introducing a cash balance plan, experts said.
“Most business owners like saving for retirement, but what trumps that is the tax savings,” Mr. Kravitz said.
“Cash balance plans are a very effective vehicle to reduce tax liability for the business owners and shareholders, as in law firms,” Mr. Gamzon said.
“When you have the right set of demographics, you want to add a defined benefit component if you want to maximize the tax benefits of retirement savings,” said David Wray, president of the Chicago-based Plan Sponsor Council of America. “Having both plans, if they're structured to benefit everyone, is a great idea.”
Nondiscrimination testing often is easier for employers to pass with cash balance plans than with defined contribution plans, which are barred from discriminating in favor of highly compensated individuals.
“The test is on the value of the benefit for the low-paid vs. the high-paid people,” Mr. Gamzon said, whereas nondiscrimination tests for 401(k) plans focus on employee contribution rates.
For example, if an employer contributes an amount equal to 15% of a 50-year-old's pay to a cash balance plan vs. an amount equal to 5% of pay for a 25-year-old, it would appear that the 50-year-old is getting more based on his or her likely higher salary, Mr. Gamzon said.
But the IRS reasons that the 25-year-old will earn interest on that 5% contribution for 40 years, whereas the 50-year-old will earn interest only for 15 years, he said.
The Pension Protection Act of 2006, followed by cash balance regulations published by the IRS in 2010, also gave cash balance plans a boost, retirement plan experts said. The regulations provided greater clarity and expanded options for interest crediting rates, making these plans more appealing to employers, they said.
“The regulatory environment has made it harder for employers to comply with traditional defined benefit funding rules,” said Dan Schwallie, a senior associate at Aon Hewitt in Cleveland and author of “Cash Balance Plan Answer Book.”
“That also speaks to why cash balance plans are more attractive now. On the surface, they track more like savings plans. They're easier for people to understand,” he said.
By contrast, “traditional defined benefit plans have been underappreciated by employees because they don't really understand them, plus retirement is a long way off for many. But what's happened in the 401(k) market has renewed interest in annuity-type products. This also is driving interest in cash balance plans,” Mr. Schwallie said.