Adapting to the Shift: The Rising Appeal of Cash Balance Retirement Plans in Today’s Rate Landscape

The landscape of retirement planning is ever-evolving, and in recent years, the rise of cash balance retirement plans (CBPs) has been notable. As the need for financial solutions that accommodate the aspirations of high earners grows, these plans present a compelling option.

Why Cash Balance Plans are Gaining Popularity

Maintaining a comfortable standard of living post-retirement is an objective many investors share. Traditional vehicles like the 401(k) have served many adequately, but for high earners who have enjoyed plush salaries over the years, the prospect of reproducing that income during retirement can seem daunting.

The constraint lies in the contribution caps set for 401(k) plans. With the IRS setting the combined contribution limit at $66,000 for 2023 (or $73,500 for those 50 or older), high earners find their potential savings stifled. CBPs emerge as a viable solution to this predicament.

Unlike traditional plans, CBPs are designed to echo the benefits of defined contribution plans but with enhanced advantages. Most notably, they offer the chance to expedite retirement savings far beyond what one could achieve with a 401(k), and given that contributions are pre-tax, they’re particularly appealing for those nestled in higher tax brackets.

The Current Trend in Cash Balance Plans

The CBP market in the U.S. has seen exponential growth and now boasts over $1 trillion in assets. Of particular interest is its rise in the “micro market,” which encompasses plans with less than ten participants. The 2023 National Cash Balance Research Report by FuturePlan highlighted that 61% of all CBPs are micro plans, with a dominant majority having assets below the $1 million mark.

Older business owners, especially those with high compensation, have shown a significant inclination towards CBPs. This is attributable to their potential to exceed current 401(k) profit-sharing limits. Furthermore, the older the investor, the more enticing CBPs become, given that the contribution limits scale with age.

It’s worth noting that the contributions made to a CBP are meticulously calculated by an actuary. Their goal is to ensure that these contributions, combined with earnings, will replace a set percentage of an investor’s income come retirement.

The New Rate Environment and Its Implications

An intriguing aspect of CBPs is the Interest Crediting Rate (IRC), which is essentially the plan’s anticipated rate of return. When the prevailing interest rates lingered near the 0% mark, a shift was observed. Financial advisors began migrating cash balance portfolios towards equities to hit their target rates.

However, with interest rates on the upswing, the dynamics are set to change. A target rate of 4%-5%, which previously seemed feasible only through equities, now seems achievable through fixed income, given the current rate environment.

This shift implies that it’s a prime time for advisors to consider de-risking cash balance plans. With a focus on capital preservation, especially for those nearing retirement, high-quality fixed income assets could be the way forward.

This doesn’t suggest that equities are obsolete in the CBP environment. Diversification remains crucial. But understanding the essence of CBPs is vital. Unlike 401(k)s, with CBPs, the spotlight isn’t on returns, but rather the contributions. Ensuring regularity in contributions and subsequent tax deductions is pivotal for a seamless experience for participants.

In Conclusion

To sum it up:

• Cash balance plans present an excellent avenue for older, high-earning business proprietors who aim to contribute beyond the limits of 401(k) profit sharing.
• The near-zero interest era saw advisors inclining towards equities to meet their target returns for CBPs.
• The current landscape with rising rates suggests that it might be opportune to shift gears and lean towards fixed income assets to match the plan’s target returns.

For financial advisors, as the quest continues to find optimal solutions for high earners nearing retirement, CBPs, when understood and used adeptly, can be a potent tool in the arsenal.