What Is a Cash Balance Pension Plan
A cash balance pension plan is a type of employer-sponsored retirement plan that combines features of a traditional defined benefit plan, and a defined contribution plan. In a cash balance plan, the employer sets aside a predetermined amount of money for each employee, usually a percentage of their annual salary, and the account grows over time with interest. Learn more about retirement plans for self-employed individuals here.
Benefits of a Cash Balance Pension Plan
There are many benefits of cash balance pension plans. Since larger contributions can be made in a cash balance pension plan, it can be a great complement to traditional retirement plans like a 401K. It also can provide a more predictable retirement income since it does not depend on market fluctuations and instead offers guaranteed interest credits. Like other retirement plans, cash balance pension plans also reduce the taxable income for businesses like law firms who make contributions for covered employees, making it a great addition to overall tax planning and employee retention.
Cash Balance Pension Plan Example
Let’s assume a law firm partner is 35 years old and makes $200,000 per year. The employer contributes 5% of the annual salary to the cash balance pension plan every year. This plan gives a fixed interest credit of 4% annually on the opening balance. Lets also assume in this example there are no plan expenses or fees, and the employee plans to retire at 65 years of age.
Each year we can calculate using the formula:
Value = (Opening Balance + Contributions + Interest Credits) – Expenses
Year 1 contributions will be $10,000 (5% of 200,000), interest will be $0 since it is the first year and there is no opening balance, so the closing balance is $10,000.
Year 2 the opening balance will be $10,000 (last year’s closing balance), the contributions will be another 5% for $10,000, interest will be 4% of the opening balance ($10,000) which comes to $400.
Value = (10,000 + 10,000 + 400) = $20,400
This process can be repeated up until age 65 to see the ending balance when retirement happens. While this is an estimated example that may be helpful for generalized assumptions, contact Wealthspire Advisors to speak to an advisor who specializes in partners at law firms to get a better understanding of your specific Cash Pension Plan, or take a look at our retirement planning checklist to ensure you’re on the right track.
Cash Balance Pension Plan Contribution Limits
The contribution limits for cash balance pension plans depend on your age and can fall between $100,000 and $350,000 annually. The overall pension balance cannot exceed $3.5 million. Be sure to talk to a financial advisor to learn more about your specific contribution limits.
