10 Things Every Cash Balance Plan Sponsor Should Know (Part 3)

10 Things Every Cash Balance Plan Sponsor Should Know (Part 3)

| March 10, 2023

 We’ve made it to Part 3 of our blog series on 10 Things Every Cash Balance Plan Sponsor Should Know. In Parts 1 and 2, we covered the essentials of how these types of plans work, and how they can provide benefits to Plan Owners aiming to save on taxes and increase retirement contributions.

In this final post, we cover four more points that will help you gain a better understanding of how these types of plans work, and how to fully maximize their potential for your Company and Plan Participants.

7. Know the Different Types of Interest Crediting Rates Available AND That a Change Can Be Made

As previously mentioned in number 4, the hypothetical account for every plan must have an Interest Crediting Rate (ICR). Your Cash Balance Plan must earn a rate of return consistent with the ICR. Yet not every plan has the same ICR, as there are typically three different ICR types to choose from.

First is the traditional ICR, which is further differentiated between a fixed interest rate or a variable rate. Fixed interest rates range mostly between 4%-6%, with Actuarial firms generally choosing a 5% or higher ICR. Variable rates are tied to one of the IRS-approved U.S. treasury instruments, such as the 30-year Treasury Bond, using an average of the yield from that instrument 1-3 months prior to the new plan year, such as the average daily yield in the month of December. The plan then aims to have the investments mirror that ICR as closely as possible. However, investment strategies rarely hit those targets exactly. They either have investment returns over or under the respective ICR. Overperformance creates a plan surplus and underperformance creates a plan shortfall. And when we have years of high market volatility, like 2000-2002, 2008-2009, 2015, and 2018, or the worse possible scenario of 2022 when stocks and bonds were both down double digits, it can create a significant shortfall, particularly if your plan has adopted a “set it and forget it” investment approach with a higher equity allocation due to a lower yielding interest rate environment. When negative returns are coupled with a mandatory fixed interest return requirement, such as a 5% ICR, you have the makings of a challenging cash flow experience for Plan Sponsors and their Owners.

As performance results begin to come in, 2022 is going to be a very painful experience. With the average return of stocks and bonds down an average of -19% and -13% respectively for 2022, a 40%/60% portfolio would have generated a negative -15% return. Added with the required 5% ICR for the plan, the shortfall could be -20%!  On a plan with $1,000,000 in plan assets, that’s a $200,000 shortfall that the Owners will need to decide how to deal with. That can be a challenge for any business, but it should be noted there have historically been several options/strategies available for Plan Sponsors to utilize to mitigate the issue including doing nothing and hoping future investment returns reduce or eliminate it, amortizing the shortfall over a period of time, or true the entire amount up with a “cash call” from the Owners to cover it. If none of those sound appealing, there may be an innovative fourth option, discussed later, to reduce or eliminate the shortfall all together without additional funding required.

The second ICR option is referred to as Market Rate or Actual Rate of Return and is a fairly recent addition to the ICR options approved by the IRS. With this option, the ICR of the Cash Balance plan for the year in question is dictated by the investment returns of the plan, not a preconceived fixed or floating rate target. If the investments return 5% in a plan year, the ICR for that year would be 5%. If they earned 1%, the ICR for that year would be 1%. This ICR option helps eliminate the variability between the ICR and the actual portfolio return that can cause the Plan Sponsor considerable pain during times of market volatility. They are one and the same under this structure. Shortfalls are limited to an individual participant account, AND only when the participant leaves the plan with a balance that is cumulatively below the contributions made into their account.

This is a significant point of differentiation between this ICR and the traditional ICR structure. Market Rate of Return significantly lessens the pain, or “threat to cash flow” that the traditional ICRs impose on Plan Sponsors each year.  You may be asking why every Cash Balance Plan Sponsor doesn’t adopt or switch to this ICR. The simple answer is threefold. First, most Plan Sponsors are not aware of it because their Advisor is not aware of it, or their Actuarial firm cannot support it. Second, this ICR structure is more complicated, which can result in a higher administrative cost. Third, the demographics of the plan may not lend itself to utilizing it.  As to this last point, certain Actuarial firms that specialize in Market Rate of Return are finding ways to overcome the demographic challenges for both start-up plans and existing Cash Balance Plans that can easily be amended for the Market Rate of Return option.  

Lastly, there is also a hybrid ICR option, where you use the traditional Cash Balance ICR for the non-Owners and the Market Rate ICR for the Owners. This option is reserved for plans that don’t have enough owners to meet the minimum participation rules for Cash Balance Plans.  

There are a number of factors to be considered in choosing the right ICR for the plan, including your demographics, plan objectives, company or firm cash flow, current plan design, and administrative costs, just to name a few. If you’re overwhelmed by the choices and not sure where to turn, working with an experienced Advisor that understands these options to help guide you through the process can be of tremendous value.

8. Know the Unique Investment Protocol for Cash Balance Plans and how it varies with each type of ICR

Cash Balance Plans have a unique investment protocol, particularly for those plans utilizing the traditional Cash Balance Plan ICRs. The first to note is these plans require the assets to be pooled. There is no participant self-direction. The investments are structured as a “one size fits all” for the plan participants, and plan participants have no say as to how the investments are managed. That is left to the Plan Committee and the ERISA 3(21) or ERISA 3(38) Advisor they have engaged. Participants only receive the “promise” of their contributions being returned to them, along with Interest Credits, as discussed above.

Plans with traditional ICRs must seek to mirror the targeted ICR each year which is, at best, a one-year investment horizon, declining throughout the year, making it challenging to consistently hit the target, net of all fees.

Plans with a Market Rate of Return ICR have a much longer “glide path” since the returns are viewed cumulatively, not year by year, and therefore can afford to take more risk earlier in the life of the plan and reduce that risk as assets in the plan increase over time. Plans with a Market Rate of Return ICR can also offer multiple investment options within the plan if it is a Shareholder Only plan or as a hybrid option if there are non-Shareholder participants in the plan, giving one group a conservative risk/return profile and another group a more moderate or growth risk/return investment profile. While this arrangement allows for a wider range of investment flexibility in the Cash Balance plan, it is more complex to administer and can be more costly as a result.

Finally, while 401(k) plans generally last the life of the Plan Sponsor, a Cash Balance Plan can pivot quickly from adoption to termination for a variety of reasons. As a result, any illiquid investments should be avoided. Investments such as non-tradable REITs, Annuities, Life Insurance, or any other investment product that has liquidity restrictions should not be utilized in a Cash Balance Plan.

9. Know the Cash Balance Plan Administrative and Recordkeeping Framework and Plan Termination Issues.    

When it comes to operating and managing a Cash Balance Plan, it’s important to be aware of the limitations that come with it. While hundreds of millions of dollars have been spent by the institutional 401(k) recordkeepers modernizing the systems and processes of 401(k) plans, the same cannot be said for Cash Balance Plans, which are “recordkept” by the local third party plan administrator/actuary, since they keep all the records on the plan. The financial institution that holds the money is the Plan Custodian, not the Recordkeeper. While the Custodian can, and often does, serve as the “cashier” of the plan, they do not provide the statements or accounting. As a result, there is a precipitous drop in the quality of recordkeeping services, website availability/technology, distribution processing, participant statements, and more with a Cash Balance Plan. Indeed, there is only one major Actuarial Firm I am aware of offering a website for participants to access and view their account balances. And that comes with an additional fee that may or may not be warranted.

That said, the Third-Party Administrator/Actuary you use will generate all the required documents, including participant statements. You may want to inquire about delivery timelines on plan amendments, testing results, participant statements, participant disclosures, and distribution processing before engaging the actuarial firm. And pin down what your responsibility is for distributing any and all participant notice requirements, as well. Also, make sure you understand just who is doing the actuarial work. Many firms outsource the administration to an independent, consulting actuary. Nothing wrong with that, but that typically means it may take longer to get your questions answered, distributions processed, little to no proactive plan design consulting, and be subject to the timelines of a service provider you do not have an engagement agreement with.     

Distributions from Cash Balance plans are also different from 401(k) plans. There is much that goes into the processing of a Cash Balance distribution, since the default payout is an annuity unless the participant elects a lump sum, and it can take 4 to 8 weeks to process at a cost that is considerably higher than that of a 401(k) plan distribution. Another reason to limit participation in the Cash Balance plan as much as possible. And know that these distributions are typically processed just once a year, not throughout the plan year. Along with this, SECURE 1.0 changed the law to allow for age 59 ½ in-service withdrawals now from Cash Balance plans, just like 401(k) plans. All it takes to unlock this door is a plan amendment to change the plan from the former age 62 requirement and a fully funded plan for the top Highly Compensated Employees to take advantage of this.

Finally, know that termination of a Cash Balance Plan involves several moving parts, depending on whether or not the plan is covered by both the PBGC and IRS, or just the IRS, the number of participant distribution payouts that must be processed, the funding level of the plan, and the experience of the firm leading you through the process. Cash Balance Plan terminations generally take one year to eighteen months and the cost may be greater than a typical 401(k) plan termination. And certain circumstances can extend this timeline and cost.   Having an experienced team can add a good deal of value since there are ways to shorten the time frame and keep the costs manageable.   

10. Understand the Need for Ongoing Education to the Plan Committee and the Plan Participants

As you have seen in the previous nine topics that we have discussed on Cash Balance Plans, these plans have several moving parts and can be extremely complex. It is very difficult for key decision makers and/or Committee Members to keep it all in perspective since there is a volume of administrative, operational, and investment information disseminated at the point of sale, typically with a sense of urgency, to meet a rapidly approaching deadline.  Employee participants-Shareholders and Non-Shareholders alike have it worse. They are generally given little more than highlights of the overall plan design and have a minimal understanding of how it works for their benefit other than as a large tax potential tax deduction.

If you have multiple Shareholders in a Cash Balance Plan, you don’t have just one Cash Balance Plan – you have multiple plans, as we see it, and an education program should be crafted to help each Shareholder/Participant understand how the plan operates, how the benefit can be maximized, how it integrates with their 401(k) and overall tax and financial plan, and what the implication will be to their net pay and ultimately household budget. Try to work with a firm that will provide Group meetings as well as one-on-one counseling with the participants to help them understand how the plan works and how it can benefit them.

Is a Cash Balance Plan Right for Your Business?

There you have it. As I have stated repeatedly throughout this 3-Part series, a Cash Balance plan provides firm and company Owners with the unique ability to accelerate their savings while dramatically lowering their taxes in a rapidly diminishing tax deduction world. However, they are complex and can create cash flow challenges for Plan Sponsors if you are not careful. It is critical to have a competent, knowledgeable, experienced team with you every step of the way.  

If you’d like help in making the right choice, our firm offers an in-depth review of your Company or Firm to determine the best retirement plan. Send a census of your Company or Firm to ssansone@sageviewadvisory.com, and I’ll have that analysis completed and back to you in 72 hours.

About Steve

Steve Sansone has over 30 years of experience in the retirement plan industry and is the Managing Director of the Valencia office at SageView Advisory Group, one of the largest Registered Investment Advisor firms specializing in retirement plans. As an Accredited Investment Fiduciary® and Certified Plan Fiduciary Advisor practitioner, Steve works with professional service groups and companies of all sizes seeking to create a world-class retirement plan experience for their plan participants. He serves as an ERISA 3(21) or 3(38) Advisor, bringing independent, conflict-free services to both Plan Sponsor Committees and retirement plan participants. Steve’s expertise in Cash Balance Plans spans nearly 20 years and is one of the few Advisors in the industry that understands both sides of the Cash Balance equation: Actuarial and Investments. He considers his work to be the greatest financial rescue mission of this time, helping people retire on time, sufficiently prepared to write the next best chapter of their life. To learn more about Steve, connect with him on LinkedIn.


SageView Advisory Group, LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where SageView Advisory Group, LLC and its representatives are properly licensed or exempt from licensure. No advice may be rendered by SageView Advisory Group, LLC unless a client service agreement is in place.