For the right business owner, a defined benefit plan can be the path to retiring with millions of dollars . The 401(k) plan is the most popular type of defined contribution plan. Unlike a 401(k) plan, which does not have a specified retirement benefit, a defined benefit plan provides for a predetermined benefit. A cash balance plan has become the most popular type of defined benefit plan. A cash balance plan, a type of defined benefit pension plan, promises an employee an employer contribution equal to a percent of each year’s earnings and a rate of return on that contribution. The benefit is always expressed as a total account balance.
What is a Cash Balance Plan?
Cash balance plans build values steadily and often at the same pace for all employees—whether they’ve worked for the employer for one or 30 years. The focus of these plans is on wealth building and “portability.” On the other hand, traditional defined benefit plans are designed to encourage career employment with one employer
Like a defined contribution plan, cash balance plans provide each employee with an “account.” The employer credits the account with “pay credit” contributions (for example, five percent of pay) and interest. This allows all employees – regardless of age – to earn benefits evenly over their careers. When workers change jobs, their cash balance plan can move with them. If the new employer doesn’t have a cash balance plan, the employee can roll their cash balance plan into an IRA.
But like a defined benefit plan, the employer bears all the investment and risk for a cash balance plan. This means that the employer always has to make sure that the employee’s account has enough to pay out total contributions plus interest – even if the plan investments do not perform well.
How Does it Work?
According to Tim Messett, President of Pension Investors Corporation of Orlando, the following example will help demonstrate the enormous retirement and tax benefits of establishing a defined benefit plan versus a 401(k) plan in the right situation.
For example, John is a doctor and has one employee, Mary, his spouse. John is 62 and Mary is 49. Let’s assume John earns $280,000 and Mary earns $75,000 in 2020. If John and his spouse established a 401(k) plan, John and Mary would be able to contribute the following:
|Employee Deferral||Employer Contribution||Total|
Whereas, if John elected to establish a cash balance defined benefit plan for his business, it would be able to make the following tax-deductible contributions based on actuary findings:
|Cash Balance Defined Benefit Plan Contribution||Total|
Cash Balance Plan Investments
Cash balance plans are funded on an actuarial basis, in the same way that traditional defined benefit plans are funded. In a cash balance plan, the amount the employer contributes to the plan each year on behalf of all employees, is based on actuarial assumptions. Unlike 401(k) plans, those hypothetical accounts are then used to determine the benefit the eligible employee will receive at retirement.
Also, unlike 401(k) plans, increases and decreases in the actual value of the plan’s investments are the responsibility of the employer and do not directly impact the benefit amounts promised to participants. Hence, a well diversified and planned investment strategy is important for cash balance plans.
IRA Financial has partnered with Pension Investors to offer the first cash balance plan that offers cryptocurrency investments. Through its strategic partnership with Gemini, IRA Financial and Pension Investors clients can establish cash balance plans that have exposure to cryptocurrency.
Although cryptocurrency investments are volatile and risky, gaining exposure to an emerging asset class that has seen tremendous growth over the last several years is an exciting opportunity for many retirement account investors. IRA Financial and Pension Investors is excited to offer its clients the opportunity to combine cryptocurrency investments via the Gemini exchange with equity and fixed income investments in a cash balance or defined benefit plan.