Cash Balance interest crediting rate

[Guest Jmar401k]

So this may be a silly question but if a plan sponsor is looking to establish a Cash Balance plan with the goal of sheltering a large chunk of money from taxes but is concerned that the variability in funding requirement that may occur due to fluctuations in the market may cause higher required contributions than he wants, could he simply set the interest crediting rate to ZERO (0%) and set his pay credit at $100k for himself and 5% for NHCEs and then invest in some ultra conservative money market account paying basically nothing?

Here's the example:

Sponsor is 10 years out from retirement. His income is 345k. He sponsors a cross-tested profit sharing plan where he maxes out each year. Those assets are invested appropriately to take advantage of market growth. In addition, he wants to accumulate another 1 million dollars and he wants to do it by taking $100,000 each year, sheltering it from taxes, and squirreling it away. He doesn't really need this 100k to earn much, getting the tax break (which brings his income from 345k down to 245k) each year is enough reason to do this. What he DOESN'T want is to have 2008 happen again and, not only see his balance reduced by half (which he'll see in his DC plan anyway) but he especially doesn’t then want to be on the hook for making a large contribution to his staff to make up for market losses. So that's the question. Would it be possible for a sponsor to choose a pay credit of $100k for himself, 5% for staff, and a ZERO percent interest rate and an investment vehicle yielding almost zero and just kick back and enjoy the tax deferral-- Thanks!

[jpod]

Can't you establish a market-rate interest-crediting formula, and then go out and invest in something perfectly safe and short-term but which pays more than zero, like bank cds? Even in this interest rate environment you may be able to get 2% if you go out 5 years on the CDs. If you have to cash in a CD before maturity to pay off a terminated participant, big deal.

[mbozek]

You can purchase 10 year treasury notes that are yielding about 2.2% that have 0 default risk. Or purchase TIPS that guarantee the rate of inflation.

[John Feldt ERPA CPC QPA]

So that's the question. Would it be possible for a sponsor to choose a pay credit of $100k for himself, 5% for staff, and a ZERO percent interest rate ...

If the benefits you describe will pass the nondiscrimination test and if you think defining the plan's crediting rate at zero percent will be okay with the IRS (I'm not sure on that, but it seems okay). Using a lower crediting rate generally translates into a much, much higher cash balance pay credit or service credit requirement for the NHCEs in order to pass 401(a)(26), so you might want to look at more scenarios than just one at zero percent.

As to the choice of investment, I tend to think of the DB assets as the conservative portion of a larger portfolio because in a DB plan (a cash balance plan is a DB plan), there is one more very important factor that does not apply to a defined contribution plan. This factor must be considered when deciding on the investments to choose, and that perhaps this factor may be the most important factor of all: the risk of having the investments not doing as well as expected is not just a loss, it is a loss that causes the employer to have to contribute more to the plan. I am not investment savvy, so don't take this as investment advice!