Data & Research July 1, 2014

Cash Balance Plans Gaining Popularity with Employers

The number of cash balance retirement plans has increased, according to a report from Kravitz, Inc.
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The “2014 National Cash Balance Research Report” says cash balance plans now make up 25% of all defined benefit (DB) retirement plans, up from only 2.9% in 2001. The report notes this increase coincides with the steady decrease in the number of traditional DB plans.

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The number of cash balance plans increased by 22% versus a 1% increase in number of 401(k) plans. The growth of cash balance plans surpassed industry projections of 15%.

Kravitz points to a number of factors behind the growth of cash balance plans:

  • Rising taxes: Higher federal, state and local tax rates have motivated many business owners to maximize tax-deferred retirement savings and take advantage of tax deductions for contributions to employee retirement accounts.
  • Hybrid appeal: Cash balance plans combine the high contribution limits of a traditional DB plan with the flexibility and portability of a defined contribution (DC) plan. Cash balance plans are also designed to avoid the common risk factors and runaway costs involved in traditional DB plans.
  • Retirement savings crisis: Media coverage of the Baby Boomers’ lack of retirement preparedness is prompting older business owners to accelerate savings and maximize qualified plan contributions.

Kravitz says an increased awareness of cash balance plans has also played a role in its growth. The authors of the report cite that as recently as five years ago, many financial professionals were unaware that these plans were even an option. The number of cash balance plans has increased from 5,244 in 2008 to 9,648 in 2012, with a projected total of 11,095 for 2013.

The report also cites a number of reasons why plan sponsors are replacing DB plans with cash balance plans:

  • Lower risk: Cash balance plans are designed to remove the interest rate risk that led to constantly changing value of liabilities in DB plans.
  • Removing cost volatility: The structure of a cash balance plan is intended to prevent runaway costs for employees nearing retirement age.
  • Easier for employees to understand and appreciate: Cash balance plans are similar to 401(k) plans with individual account balances and some plans offering participant websites with daily updates.
  • Consistency and fairness: These plans allow for more consistent contributions to employees, rather than uneven age-based contributions.
  • Full portability: Account balances can be rolled over to an individual retirement account (IRA), which is a useful option for today’s mobile work force in which many employees change jobs every few years.

The report notes that 96% of employers that offer a cash balance plan do so in combination with one or more DC plans. The most common combinations are with either a profit-sharing plan (95.7%) or a 401(k) (85.5%), which allow business owners to maximize contribution levels, flexibility and tax efficiency, Kravitz says.

Cash balance/DC combination plans also offer an advantage to participants in the form of increased employer contributions overall. Specifically, the average employer contribution is 6.3% for a cash balance/401(k) combination versus 2.6% for just a 401(k) plan.

Plan sponsors need to be aware of what testing and compliance issues they may face with the Internal Revenue Service (IRS) if they go with a cash balance/401(k) combination plan, cautions the report. The IRS will require cross-testing to ensure fairness to all employee groups across all compensation levels, so it will be important for the plan sponsor to have an experienced and technically skilled actuarial consultant to design a cash balance retirement program that will achieve the plan sponsor’s goals, as well as pass all IRS tests every year.

The report notes that small and mid-size businesses are driving the growth of cash balance plans, with 87% of such plans operating at companies that have fewer than 100 employees. Reasons small and mid-size companies find cash balance plans so attractive include:

  • Cost efficiency and tax efficiency: After staff costs, taxes are usually the largest expenditure for small businesses. Cash balance plans are designed to help owners with a significant tax deduction for employee contributions, plus tax-deferred retirement contributions for themselves.
  • Asset protection: As with any IRS-qualified retirement plan, cash balance assets are protected in the event of a lawsuit or bankruptcy.
  • Catching up on delayed savings: Age-weighted contribution limits allow older owners to squeeze 20 years of savings into 10 years.
  • Attracting and retaining talented employees: Defined benefit plans such as cash balance have a greater appeal to many employees than a typical 401(k) plan, and allow small business owners to offer a competitive recruitment advantage.

The report also examines a number of other areas including plans by year established, plans by asset size, interest credit rating chosen by plan sponsors, and regional concentration of plans.

Kravitz, Inc. has been tracking the annual growth rate of cash balance plans since 2008. Its annual reports analyze data from the most recent Internal Revenue Service Form 5500 filings.

The full report can be found here.

In Practice July 1, 2014

Using 403(b) Employer Contributions as Compensation

Advisers who serve school districts can add value by sitting down with employees to make sure they appreciate the benefits they receive through a 403(b) plan.
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Public K-12 school systems that offer 403(b) plans have an extra tool for solving certain reward and budget issues. As their 403(b)s are not subject to the Employee Retirement Income Security Act (ERISA) and not subject to nondiscrimination testing for employer contributions, they have an opportunity to solve a number of problems using employer contributions as compensation, according to Ellie Lowder of TSA Consulting and Training Services in Tucson, Arizona. Non-electing churches and qualified church-controlled organizations (QCCOs) can use employer contributions in similar ways as well, she told attendees of the National Tax-Sheltered Savings Association’s (NTSA’s) 2014 403(b) Summit.

Lowder said advisers can add value to the school districts they serve by offering to personally sit down with employees to make sure they appreciate the benefits the school district is offering and make sure they manage the savings properly. In addition, an adviser can reach out to a school district looking for a superintendent to talk to the district about challenges in attracting or hiring a supervisor. For example, the tax-paying public may have a problem with offering a high salary, so an adviser can tell the district it can sweeten the pot for an incoming superintendent by making employer contributions to the 403(b).

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For public schools, employer contributions may be used to recruit hard-to-find teachers, enhance compensation for superintendents, reduce unfunded liabilities for unused leave pay, and retain the most experienced teachers (who usually are at the top of the salary schedule). By making contributions to 403(b)s rather than increasing salaries, they avoid payroll taxes and, in most states, Social Security and FICA taxes.

Lowder said she is seeing some districts attracting math and science teachers from other districts by telling them, “If you come work for us, we’ll make a contribution to your 403(b) account.” Similarly, 403(b) employer contributions are also being used to attract teachers to inner city schools for which it is hard to recruit teachers. To retain teachers, districts may promise an employer contribution for every year a teacher stays. This is especially helpful if a teacher has reached the top of a district’s pay scale and is no longer getting a bump in salary.

Some school districts may have a policy where teachers may accumulate unused leave pay—for example, 10 days a year up to 200 days—to be paid when the teacher leaves employment. Many districts find it’s a liability they cannot pay, so they negotiate with the teacher’s union an alternate benefit—instead of paying a lump sum from which taxes will be taken, they may reduce accumulated leave pay to five days per year up to 100 days, and make up the remainder with 403(b) contributions.

Considerations for Using Employer Contributions as a Reward

Lowder said if union members are impacted by employer-contributions-as-compensation offerings, school districts must first discuss the offerings with the union. They should also check state and local laws, but most states will permit employer contributions.

Employer contribution provisions must be added to a district’s plan document, or the appropriate option must be checked in the plan adoption agreement. Lowder noted the plan document language is general, permitting employer contributions, but language specific to the employee and the reward agreement will be in a separate administrative policy adopted by the school board. She suggested school districts make the reward discretionary so they are not locked in. If 403(b) employer contributions are part of a superintendent’s benefit, provisions should be put in, or added to, the superintendent’s employment contract.

Although there is no nondiscrimination testing required for employer contributions, they still cannot exceed annual statutory limits, so these rewards should be coordinated among plan providers or third-party administrators to ensure limits are adhered to.

Lowder reminded attendees that Internal Revenue Code Section 403(b)(3) says includable compensation can be counted for up to five full years following the year of severance of service, meaning a district can make employer contributions for up to five years following a teacher’s severance. She said the most common utilizations of post-employment contributions are to replace the payment of unused sick pay, to incent early retirement (sometimes used to save budget dollars by eliminating higher salaries and fringe benefits for teachers who take the incentive), and to buy out the contract of a departing superintendent (the district will save money on the lump-sum pay, and the superintendent will benefit because the lump sum could put him or her in a higher income tax bracket).

Lowder noted employees receiving post-employment contributions must establish a 403(b) account while still employed—no cash option can be given to the employee or group of employees receiving post-employment contributions—and benefit accruals will cease in the month of a recipient employee’s death.

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