Cash Balance Plans Frequently Asked Questions By Robert Mand, Esq. Introduction This piece is intended to provide owners of small to medium size businesses with answers to frequently asked questions about cash balance plans. Focus The focus of the questions and answers is “owner-centric” retirement plans, those plans that provide the major part of the contributions to business owners, their family members and favored employees, while providing lower contribution amounts to all other employees. Frequently Asked Questions Question 1 : What is a cash balance plan? Answer 1 : A cash balance plan is a type of qualified retirement plan that guarantees participants a retirement benefit. ______________________________________________________________________________________________________ Question 2 : Who makes the contributions to a cash balance plan? Answer
2 : The company that establishes the plan makes the contributions to the cash balance plan, not the plan participants. Question 3 : How is the contribution amount determined? Answer 3 : The contribution formula is determined by an actuary when the plan is established, so that the contributions being made to the different categories of participants meet the objectives of the owners. The contributions must meet the requirements of IRS regulations, so that the plan is not considered to be discriminatory in favor of owners, family members and highly compensated employees. Thus, at the outset, the owners must determine how much the company is to contribute for each category of employees. Most often, company owners and family members are in the favored group, and receive larger contributions than all other employees, who receive lower contributions. Question 4 : Are the annual contribution amounts predictable, so that a company budget for the contribution? Answer 4 : When the plan is designed, the company establishes an annual interest rate to be credited to the account balance of each plan participant. Since the interest rate is guaranteed, the company’s contribution is adjusted to account for differences between the guaranteed interest rate and the interest rate actually earned by the plan’s investments. So as long as the earnings rate is close to the guaranteed rate established in the plan, then the annual contributions will fall within a reasonable range of the predicted contribution amount set by the plan contribution formula. ______________________________________________________________________________________________________ Question 5 : Are the annual contributions mandatory? Answer 5 : Yes, annual contributions to a cash balance plan are mandatory. Question 6 : What are the annual contribution limits for each participant? Answer 6 : The law does not set a contribution limit for each participant, as is the case in a 401(k) plan. Rather, the sum of the annual contributions and guaranteed interest rate for each participant at their retirement date may not exceed the lump sum that is the actuarial equivalent of the maximum annual retirement benefit. For 2011, the maximum annual retirement benefit for a plan participant is $195,000 per year. This equates to a lump sum of approximately $1,850,000. This results in larger contributions being permitted for employees who are closer to retirement, since there is less time to accumulate the required lump sum. Question 7: How do company contributions to a cash balance plan differ from...
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