A Defined Benefit/Cash Balance plan may be considered when reviewing retirement plan options.
In a defined benefit pension plan, an employer commits to paying an employee a specific benefit for life beginning at his or her retirement. The amount of the benefit is known in advance and is usually based on factors such as age, earnings, and years of service. For 2022, the maximum retirement benefit permitted under a defined benefit plan at age 62 after 10 years of participation is $245,000. The $245,000 limit is adjusted each year to reflect changes in the cost-of-living index.
The employer is responsible for making the decisions about how much money to contribute and how to invest it. Employer contributions to the defined benefit plan are based on a benefit formula that calculates the investments needed to meet the defined benefit.
Defined benefit plans distribute their benefits through life annuities. Under a single life annuity option, employees receive equal monthly benefit payments for the rest of their lives. If you are married and you choose the joint and survivor option, upon your death your surviving spouse can continue to receive distributions of at least 50 percent of your periodic payment amount. Some plans may also allow you to receive your entire benefit in one lump sum payment at your retirement or termination of employment.
Defined benefit plans and Cash Balance Plans can be simple or complex – it all depends on your unique needs and goals. A Defined Benefit plan or Cash Balance plan can also be used in combination with another type of plan, such as a 401(k)/Profit Sharing plan, in order to achieve an even higher contribution level.
Advantages to Defined Benefit/Cash Balance plans include:
- Contributions are tax-deductible.
- A guaranteed and predictable monthly benefit for the life of the participant beginning at his or her retirement.
- Employers can generally contribute (and, therefore, deduct) more to a Defined Benefit plan than to other types of plans.
- Substantial benefits can be provided to key employees, even with early retirement.
- Benefits are not dependent on asset returns.
Disadvantages to Defined Benefit/Cash Balance plans include:
- The requirement of filing a Form 5500 annually.
- The necessity of making the annual contribution in a timely manner despite potential financial hardship.
- The complexity of defined benefit pension plan administration.
- The difficulty in effectively communicating the plan to employees.
How do Cash Balance plans differ from traditional pension plans?
While both traditional Defined Benefit plans and Cash Balance plans are required to offer payment of an employee’s benefit in the form of a series of payments for life, traditional Defined Benefit plans define an employee’s benefit as a series of monthly payments for life to begin at retirement, but cash balance plans define the benefit in terms of a stated account balance. These accounts are often referred to as “hypothetical accounts” because they do not reflect actual contributions to an account or actual gains and losses allocable to the account.
Is a Defined Benefit plan right for you?
JC Actuarial Benefit Consultants, Inc. will help you choose the type of benefit plan that will benefit your employees, maximize your tax savings and help your retirement assets reach their fullest potential.