I’ve heard that I need to have a 5-year commitment. Is this true and what does the funding look like?

For cash balance plans, the “5-year commitment,” is typically a TPA recommendation to provide a blanket expectation of the lifespan of a cash balance plan. Although these plans are permanent in the eyes of the IRS, with reasonable cause you can terminate the plan at any time.

A majority of our clients keep these plans for an average of 5 – 7 years, but we do have clients who terminate before then or keep them open for longer periods. Due to the many factors involved with calculating cash balance contributions, (mortality tables, IRS limitations, compensation, investment performance, etc.) it’s hard to project exact amounts for the next 5 years of contributions to the cash balance plan.

If all things were to remain the same, we could expect that the funding target would increase around 5% a year. Each year we will calculate a funding range based on age, compensation, and investment performance.

Here is a brief overview of each factor and how they affect the range each year starting in year two:

• Age – each year participants get closer to retirement so that always increases the amount that can be put in

• Compensation – creates a base for how much can be put into the plan. If compensation decreases it would shift the funding range to a lower minimum and maximum, and if compensation increases that will increase minimum and maximum

• Investments – if investments under-perform, contribution will have to offset some of the loss (however it isn’t dollar for dollar, it would increase the maximum funding amount) and if the investments perform really well, it will limit the maximum funding amount which would reduce the deduction for the year.

This is why we typically recommend that cash balance plan funds are invested in a conservative and less risky way. This helps keep level funding ranges. We will also include a target funding amount. This is the amount which will keep contributions on target with where the funding should be for that year.

Each year that the funding amount is in line with the target, it will maintain a flexible funding range for following years. This allows some discretion to contribute a larger amount in a good financial year and a lower amount in a lean year. After a few years of funding at the target will expand the funding range, until the minimum is $0 and the maximum will be the IRS limit for the year.

Although, if funding is consistently at the low end of the range, then future minimums will start to increase and push funding amounts higher. Likewise, if plans are consistently funded at the high end of the range, eventually the maximum contributions will start to decrease, and future funding amounts can be limited.