The Cash Balance Plan Alternative

A cash balance plan is a type of defined benefit plan that resembles a defined contribution plan. For this reason, these plans are referred to as hybrid plans. A traditional defined benefit plan promises a fixed monthly benefit at retirement usually based upon a formula that takes into account the employee’s compensation and years of service. This plan looks like a defined contribution plan because the employee’s benefit is expressed as a hypothetical account balance instead of a monthly benefit.

Each employee’s “account” receives an annual contribution credit, which is usually a percentage of compensation, and an interest credit based on a guaranteed rate or some recognized index like the 30 year Treasury rate. This interest credit rate must be specified in the plan document. At retirement, the employee’s benefit is equal to the hypothetical account balance which represents the sum of all contribution and interest credits. Although the plan is required to offer the employee the option of using the account balance to purchase an annuity benefit, employees generally will take the cash balance and roll it over into an individual retirement account (unlike many traditional defined benefit plans which do not offer lump-sum payments at retirement).

As in a traditional defined benefit plan, the employer bears the investment risks and rewards. An actuary determines the contribution to be made to the plan, which is the sum of the contribution credits for all employees plus the amortization of the difference between the guaranteed interest credits and the actual investment earnings (or losses).

One of our healthcare clients is an affiliated service group made up of a specialty clinic, surgery center and individual shareholder physician companies. They came to us with a 401(k) profit sharing plan that allowed for deferrals up to the maximum dollar limit of $18,000 (or $24,000 for those age 50+), a safe harbor matching contribution of up to five percent of compensation and profit sharing contributions of 5.7 percent of compensation plus five percent of compensation in excess of the social security wage base ($127,200). Under this plan, physician shareholders were limited to contributions of $54,000 (or $60,000 for those age 50+).

We designed a cash balance pension plan to be added to the group’s existing 401(k) profit sharing plan to increase the amount shareholder physicians were able to put away for retirement. The existing 5.7 percent profit sharing contribution for employees allows each shareholder physician to have an additional cash balance contribution of $47,700. This resulted in an 89 percent increase in the total contributions for shareholder physicians from $54,000 to $101,700 (or from $60,000 to $107,700 for those age 50+).

We also proposed an increase in cash balance contributions for shareholder physicians over age 50 the following year by increasing the profit sharing contribution for employees to at least 7.5 percent of compensation. We provided this increase in profit sharing without increasing the amount of total employer contributions by eliminating the matching contribution. This change in plan design resulted in a potential savings of $136,100 for the employer. At the same time, it provided more than three times the cash balance contribution for shareholder physicians over age 50.