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Cash Balance Plans - Q&A

Cash Balance Plans - Q&A

February 24, 2020

Questions & Answers 

Which employees do you have to include in your cash balance plan? 

You generally must include all employees who are at least 21 years old and have at least one year of service. Two years of service may be required for participation as long as the employee will be 100% vested immediately upon entering the plan. If desired, you can impose less (but not more) restrictive requirements. 


Tip: For eligibility purposes, a year of service is a 12-month period during which the employee has at least 1,000 hours of service.  


In addition, your cash balance plan is subject to federal restrictions regarding how many employees must participate in the plan. Specifically, on each day of the plan year, a cash balance plan must benefit no fewer than the lesser of (1) 50 of your employees, or (2) 40% or more of all of your employees, and at least 2 employees must benefit (unless there is only 1 employee in the company). 


When must plan participation begin? 

An employee who meets the plan's minimum age and service requirements must be allowed to participate no later than the earlier of: 

  • The first day of the plan year beginning after the date the employee met the age and service requirements, or
  • The date six months after these conditions are met


What is a highly compensated employee? 

For 2019, a highly compensated employee is an individual who: 

  • Was a 5% owner of the employer during 2018 or 2019, or
  • Had compensation in 2018 in excess of $120,000 ($125,000 in 2019) and, at the election of the employer, was in the top20% of employees in terms of compensation for that year.

For purposes of defining a highly compensated employee, compensation includes all taxable personal services income (such as wages, salaries, fees, commissions, bonuses, and tips), as well as elective or salary-reduction contributions to 401(k) plans and cafeteria plans. 


When do employees have full ownership of the funds in their accounts? 

The process by which employees acquire full ownership of their plan benefits is called "vesting." Employer contributions must be 100% vested after three years of service. 


Tip: A plan can have a faster, but not slower, vesting schedule than the law requires. 


What happens to an employee's account if the employee terminates employment before he or she is 100% vested? 

If a participant in your cash balance plan separates from service before being 100% vested in the plan, the employee will forfeit the amount that is not vested. The amount forfeited can then be used to reduce future employer contributions under the plan or can be reallocated among the remaining participants' accounts. The IRS generally requires forfeiture allocation in proportion to participants' compensation rather than in proportion to their existing account balances. 


Do you need to receive a favorable determination letter from the IRS in order for your plan to be qualified? 

No, a plan does not need to receive a favorable IRS determination letter in order to be qualified. If the plan provisions meet IRS and ERISA requirements, the plan is considered qualified and is entitled to the accompanying tax benefits. However, without a determination letter, the issue of plan qualification for a given year does not arise until the IRS audits your tax returns for that year. 


By that time, it may be too late for you to amend your plan to correct any disqualifying provisions. A determination letter helps to avoid this problem because auditing agents generally will not raise the issue of plan qualification if you have a favorable determination letter (or if a preapproved prototype plan is used). 


What happens if the IRS determines that your plan no longer meets the qualified plan requirements? 

The IRS has established programs for plan sponsors to correct defects. These programs are designed to allow correction with sanctions that are less severe than outright disqualification. Your tax professional will be able to assist you in following these programs should the need arise. However, if you are unable to correct the defects in your plan as required, the plan may be disqualified. Loss of a plan's qualified status results in the following consequences: 

  • Employees could be taxed on employer contributions when they are made, rather than when benefits are paid
  • Your deduction for employer contributions may be limited
  • The plan trust would have to pay taxes on its earnings
  • Distributions from the plan become ineligible for special tax treatment (see above), and cannot be rolled over tax free

The information in this newsletter is not intended as tax, legal, investment, or retirement advice or recommendations, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented, nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Broadridge Advisor Solutions. © 2019 Broadridge Investor Communication Solutions, Inc. CRN202110-255702