So you are planning on setting up a cash balance plan. You have heard about interest credits, but really don’t know your options. In this post, we take a close look at the cash balance plan interest crediting rate.
A cash balance plan provides benefits to a participant using a different mechanism than the traditional defined benefit plan. The following two paragraphs describe first the allowable interest credits and then the various pay credit structures that are commonly used.Are you looking to get over $100,000 into retirement? Get a FREE Illustration showing your contribution and tax savings today. See for yourself why our plans are one of the best tax deferrals!
The interest credit must be given at least annually. Some plans credit interest more frequently, such as monthly, quarterly or semi-annually. The plan document will describe how to carry out the calculation including the interest rate to be used and how it is applied to the account balance.
In some cases, a minimum interest rate may be defined. For example, the interest rate could be defined to be the rate published for 30-year Treasury securities, but not less than 4%. A definition of this type is often necessary to help the plan satisfy the minimum accrual rules of IRC §411(b). A maximum interest rate may also be used.
Cash Balance Plan Interest Crediting Rate
Below is a list of valid interest credit options.
- The discount rate on 3-month Treasury Bills
- The discount rate on 6-month Treasury Bills or 12-month Treasury Bills
- The yield on 1-year Treasury Constant Maturities
- The yield on 2-year or 3-year Treasury Constant Maturities
- The yield on 5-year or 7-year Treasury Constant Maturities
- The yield on 10-year or any longer period Treasury Constant Maturities
- Annual rate of change of the Consumer Price Index
- First or second segment funding interest rate
- Any of the three lump-sum segment rates
- Actual asset rate of return (only allowed in certain cases)
IRS rules require the interest crediting rate be no more than a market rate (it is not clear exactly what a market rate is). Generally, the interest rate is applied to the beginning of year account balance. The higher the rate the more generous the benefit is. This would be paid for by the employer in the form of higher contribution amounts.
A participant can rely on these interest credits just as if it was a GIC. Usually the rate is set once a year in advance of (or at) the beginning of the year. It is possible for the interest credit rate to be negative in a particular year.
In that case, it is required that the participant receive at least the sum of the pay credits made to their accounts since they started participating in the cash balance plan. This means that each participant has a floor below which their account balance cannot fall.Are you looking to get over $100,000 into retirement? Get a FREE Illustration showing your contribution and tax savings today. See for yourself why our plans are one of the best tax deferrals!
As a result, plans tend to impose a minimum interest rate credit to avoid having to compare the current account balance against the sum of the pay credits each year (or whenever a participant is entitled to a distribution).
In summary, you have plenty of options when it comes to the cash balance plan interest crediting rate. Make sure that you discuss the issue with your administrator in order to get a rate that will work well in your situation.