This is the first in a series of guest blog posts that we will be providing to our readers. The posts will come from some of our professional partners in an effort to provide interesting and useful information not directly within our areas of expertise. Today’s post is by Vince Spina, President of Harbridge Consulting Group, LLC. Harbridge Consulting Group, LLC is a division of BPAS, the largest actuarial consulting firm headquartered in New York State outside of New York City with offices in Syracuse, Rochester, Manhattan and East Hanover, New Jersey.
A Cash Balance Plan is meant for high cash flow individuals who are already making the maximum contributions in a 401(k) Plan. It is technically a Defined Benefit (DB) Plan that looks (to participants) like a Defined Contribution (DC) Plan such as a 401(k) Plan. This is because benefits are communicated to participants as account balances, which equal the sum of annual service credits and interest credits. Service credits can either be a flat dollar amount (e.g. $500) or a percentage of pay (e.g. 5%). Interest credits can be a flat percentage (e.g. 4%), tied to an index that adjusts annually (e.g. 5 or 10 year Treasuries), or even equal to the actual return on plan assets (note, if using actual return on plan assets, there is a minimum cumulative credit of 0% over each participant’s time in the plan).
Annual contributions for employees other than owners will likely need to be at least 7.5% of pay in order to satisfy cross-testing nondiscrimination requirements.
A few common questions regarding cash balance plans:
High cash flow clients are typically a good fit for the cash balance type of DB plans. What qualifies someone as high cash flow and makes them a good candidate?
These candidates are those who own businesses with relative predictability of income. They typically include physicians who are specialists (e.g. Radiologists, Anesthesiologists, Orthopedic Surgeons, etc.), Orthodontists, and small business owners who have niche products where their net income typically exceeds $500K annually.
Tell us a little more about the administration required for such a program. Can high cash flow individuals manage these plans and their investments on their own or should they seek outside assistance?
These plans require a written plan document and annual administration meant to keep the plan in compliance with arcane Internal Revenue Service regulations. If a Cash Balance Plan is implemented, the plan will need the services of an Enrolled Actuary who performs a valuation of the plan every year. While this sounds complex and potentially costly, for many of our clients the savings in FICA tax often exceeds the after-tax cost of administration, resulting in the plan actually producing cost savings to the employer. Furthermore, I would not recommend someone manage these investments on their own. ERISA requires a plan sponsor follow a “prudent man” rule, and unless a sponsor employs someone internally who is an investment expert, they run the risk of violating the “prudent man” rule by trying to do it themselves.
What is the range of money someone can save on an annual basis with such a plan?
A Cash Balance Plan is meant for an owner or high income employee who already is making the maximum contributions in a 401(k) Plan of $52,000 (and $57,500 if the individual is age 50 or older). Maximum contributions made to a Cash Balance Plan on behalf of an individual are age-specific and range from $68,000 for someone age 35 increasing to $112,000 for someone who is 45 and can exceed $235,000 for someone over age 60. These amounts are in addition to the amounts contributed to the 401(k) Plan. While the maximums can be extraordinary, many plans are initially established with contribution levels underneath the maximums that are allowable but still supplementing what is contributed to the 401(k) Plan.
What is a good rule of thumb to determine the amount of money someone will need to comfortably retire?
In many circles the easy thing to say is accumulate 10 times your annual salary….that coupled with Social Security will provide a fairly comfortable lifestyle in retirement. I think this is a pretty reasonable target. This includes the value of company sponsored retirement plans. That may sound daunting; however, many government employees retire with pension and retiree medical benefits worth substantially more than 10 times their final salary. For a high income earning with a lifestyle commensurate with that income, the target might actually be 15 to 20 times annual salary. The key, as everyone knows, is to start early and let compounding over many years be your friend. If you can’t start early, you’ll be forced to dramatically increase your contributions later in your career…..which is what a Cash Balance Plan allows a business owner to do.