Cash Balance Benefit Question

[metsfan026]

Good evening, I hope everyone had a Happy Holiday and has a Happy New Year!

Just a quick question regarding the benefits in a Cash Balance Plan.  If the document says Employee A gets a benefit of $100,000 and Employee B gets $20,000.  Is there a required salary they need to get to get that benefit, or since the document states a set dollar amount as long as the testing passes there is no issue (the only two employees are 50% owners, so discrimination isn't an issue).

Theoretically, can Employee A take a $10k salary and still get the $100,000 benefit?

Thanks in advance!

[John Feldt ERPA CPC QPA]

A cash balance plan is a defined benefit plan. The maximum benefit that can be paid out from a defined benefit plan is limited by Internal Revenue Code Section 415. This is a very important distinction when comparing how this plan gets handled when compared to a defined contribution plan, like a 401(k) profit sharing plan, where a participant just gets their account with investment returns.

A defined benefit plan cannot pay the participant more than the maximum allowed, even if investments do great, and even if the amount defined in the plan’s formula is higher than the payout maximum. 

One of the two main factors that limits the maximum benefit payable from the plan to a participant is the participant’s highest consecutive 3-year average compensation (wages).

As I’m sure you can guess, an extremely low consecutive 3-year average compensation for the participant will result in an extremely low maximum benefit that can actually be paid to them from the plan. And when they reach that maximum, it is very likely the lump sum they can be paid after that will begin to decrease with time. Yes, decrease.

Your favorite local enrolled actuary can tell you if this will work for employee A and tell you how long (or short) of a period it will be before they hit their ultimate lump sum 415 limit and can’t be paid out any higher amounts from the plan without establishing a higher consecutive 3-year average compensation. 

[metsfan026]

3 hours ago, John Feldt ERPA CPC QPA said:

A cash balance plan is a defined benefit plan. The maximum benefit that can be paid out from a defined benefit plan is limited by Internal Revenue Code Section 415. This is a very important distinction when comparing how this plan gets handled when compared to a defined contribution plan, like a 401(k) profit sharing plan, where a participant just gets their account with investment returns.

A defined benefit plan cannot pay the participant more than the maximum allowed, even if investments do great, and even if the amount defined in the plan’s formula is higher than the payout maximum. 

One of the two main factors that limits the maximum benefit payable from the plan to a participant is the participant’s highest consecutive 3-year average compensation (wages).

As I’m sure you can guess, an extremely low consecutive 3-year average compensation for the participant will result in an extremely low maximum benefit that can actually be paid to them from the plan. And when they reach that maximum, it is very likely the lump sum they can be paid after that will begin to decrease with time. Yes, decrease.

Your favorite local enrolled actuary can tell you if this will work for employee A and tell you how long (or short) of a period it will be before they hit their ultimate lump sum 415 limit and can’t be paid out any higher amounts from the plan without establishing a higher consecutive 3-year average compensation. 

Right, I understand all of that but in the Cash Balance Plan the benefit can be set as a flat dollar amount regardless of the three-year compensation.  In this case the benefit named in the Plan Document is greater than the salary (and potentially by a substantial margin).  I also know that, when there are additional employees, a lower salary is going to increase the calculated EBAR, making compliance testing extremely difficult to pass (in this case, as a 2-person plan with no non-highly compensation, that's not an issue).

So, in this case, in a cash balance plan I think it is ok to have a benefit that ends up significantly higher than the compensation for the year (with no compliance issues);

[Bri]

We have contribution credit formulas for older HCEs that routinely are defined along the lines of "140% of compensation up to a maximum of 200,000". 

Both would look wacky when compared to the 415(c) limit, but since prior pay should have established a nice 415(b) limit, this will often not only work, the client will love it and the 401a4 testing doesn't hurt as much as you might think, too.  (Not testing on a contributions basis, though - that's for certain...practically!)

 

[metsfan026]

55 minutes ago, Bri said:

We have contribution credit formulas for older HCEs that routinely are defined along the lines of "140% of compensation up to a maximum of 200,000". 

Both would look wacky when compared to the 415(c) limit, but since prior pay should have established a nice 415(b) limit, this will often not only work, the client will love it and the 401a4 testing doesn't hurt as much as you might think, too.  (Not testing on a contributions basis, though - that's for certain...practically!)

 

Thanks.  So technically he can have a $70k credit, and show lik a $20k salary type of thing?

[david rigby]

9 hours ago, metsfan026 said:

Right, I understand all of that but in the Cash Balance Plan the benefit can be set as a flat dollar amount regardless of the three-year compensation.  

What does this mean?

[Bri]

It's not unreasonable that it may happen, but your actuary will still need to verify that the 70K wouldn't exceed the individual's 415(b) limit, which of course then brings in your high-3 (presumably prior years from the past) average and age into the calculations.

2 hours ago, metsfan026 said:

Thanks.  So technically he can have a $70k credit, and show lik a $20k salary type of thing?