Small- and mid-size businesses are scarfing down cash balance retirement plans as if they were candy. The number of such plans experienced a record 32 percent growth in 2013 and that much of the growth was driven by the small/medium business crowd, according to a new report.
By comparison, the number of new 401(k) plans increased by just 3 percent, according to Los Angeles-based plan administrator Kravitz Inc. which released the study.
The data reflect the year 2013, the most recent year for which complete Department of Labor information on the plans is available, Kravitz said.
The small/medium presence in the cash balance plan market is overwhelming. According to the report, 89 percent of cash balance plans today are in place at firms with fewer than 100 employees.
Moreover, the highest growth over the past five years has been at companies with fewer than 25 employees.
The numbers are sure to dazzle insurance and employee benefits professionals, many of whom specialize in the small- and mid-sized business market.
Some advisors may not have heard of the plans. Although they debuted in 1985, they got off to a slow start due to legal uncertainties and some older workers objecting to perceived discrimination issues. But since 2001, cash balance plans have increased from less than 3 percent to 28 percent of all defined benefit (DB) plans in 2013, according to Kravitz. The company designed its first cash balance plan in 1989 and now administers more than 550 such plans among its 1,200 retirement plan total.
In terms of overall growth, cash balance plans surged by 850 percent from 2001 to 2013, when the total reached more than 12,700 plans and more than 12.3 million participants, the report said.
What are they?
Cash balance plans are a type of DB retirement plan. They define the employee’s retirement benefit in terms of a stated account balance, such as $100,000 or some other figure, according to the Department of Labor (DOL). By comparison, traditional DB plans — more commonly called pensions — define an employee's benefit as a series of monthly payments for life to begin at retirement.
There are other differences too, but the key is that cash balance plans have more of an “account” style than do traditional DB plans. The accounts increase yearly via employer contribution (a flat amount or a percent of pay) and through an interest credit, as spelled out in the plan document. They’re sometimes called “hybrid” plans, Kravitz noted, because they combine the high contribution limits common to traditional DB plans with some 401(k)-type flexibility and portability.
Here’s the thing for insurance and benefits professionals: To stay in the know, be aware that 1) these plans definitely are turning heads in the small/medium business market, and 2) there are business reasons for this.
The topics may come up during business plan reviews, so here are some highlights.
More than half (55.7 percent) of the plans are at firms with just one to nine participants, according to the Kravitz report. So, in this market, “small” can be very, very small. Another 22.8 percent are at firms with 10 to 24 participants, and 10.8 percent are at firms with 25 to 99 participants.
Many leading national law firms and medical groups have cash balance plans too, and so do some Fortune 100 companies. But it’s still the smaller firms that are flocking to the plans.
For most firms, a cash balance plan is an “add-on” to an existing 401(k) profit sharing plan, the report said. Offering two plans may seem like retirement benefits overkill to the uninformed but the approach works financially for many owners as well as the employees, as seen below.
Why they like cash balance
According to Kravitz, small-business owners are interested in the cost and tax efficiency the plans afford. The business receives “a significant tax deduction for employee contributions, plus generous tax-deferred retirement contributions for themselves,” the report said.
Another attraction is that these are IRS-qualified retirement plans. As such, the cash balance assets are “protected in the event of a lawsuit or bankruptcy,” the report said. DOL puts it this way: The cash balance plans “are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corp.”
For older business owners, the attraction may be the plans’ ability to help catch up on delayed savings, since the “age-weighted contribution limits allow older owners to squeeze 20 years of savings into 10.”
Finally, many employees view cash balance plans as “more appealing” than a typical 401(k) plan, the report said. That can help with attracting and retaining talented employees.
Some of the appeal may be the fact that employees don’t have to reduce their take-home pay in order to receive an employer contribution, since the contributions are not based on a “match,” the report said.
Also, employees don’t have to choose their own investments or bear investment risk. Plan assets are pooled and typically invested by the plan sponsor using a conservative benchmark. And when employees leave or retire, “they have the choice of an annuity option or a lump sum that can be rolled over into an IRA.”
About combining plans
The report notes that some firms offer the cash balance plan in combination with a 401(k). When that is the case, which is frequently, the contributions to employee retirement accounts are higher.
For instance, in 2012, the average employer contribution to non-owner employees came to roughly 6.3 percent of pay if offering both 401(k) and cash balance plans, the report said. However, if offering only a 401(k) plan, the average contribution came to just 2.8 percent of pay, according to recent data that Kravitz cited from a Plan Sponsor Council of America report.
Some employers may not want to offer both types of plans due to the high contribution level. However, Kravitz pointed out that cash balance plans require employers to contribute 5 percent to 8 percent of pay to non-highly compensated employees “in order to contribute larger amounts for the owners.” That last can be a strong incentive to offer both types of plans.
InsuranceNewsNet Editor-at-Large Linda Koco, MBA, specializes in life insurance, annuities and income planning. Linda can be reached at [email protected].
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