Is There a Forfeiture Account in a Cash Balance Pension Plan?
The short answer is generally no, a traditional forfeiture account as commonly found in defined contribution plans like 401(k)s does not exist in a cash balance pension plan. Cash balance plans operate fundamentally differently.
Understanding Forfeitures in Retirement Plans
To understand why forfeiture accounts don’t typically exist in cash balance plans, it’s essential to understand the concept of forfeitures and how they arise. Forfeitures occur when an employee leaves a company before becoming fully vested in their employer’s contributions to a retirement plan. In defined contribution plans, these unvested amounts are “forfeited” back into the plan.
How Forfeitures Work in Defined Contribution Plans
In plans like 401(k)s, the employer contributions usually have a vesting schedule. If an employee leaves before meeting the vesting requirements (e.g., working for a certain number of years), they lose their right to the unvested portion of the employer’s contributions. These forfeited amounts are then often used to:
- Reduce future employer contributions
- Pay plan administrative expenses
- Allocate to remaining participants
These forfeited amounts are tracked in a forfeiture account until they are used for one of the permissible purposes.
The Unique Structure of Cash Balance Plans
Cash balance plans are a type of defined benefit plan, despite resembling defined contribution plans with their individual account-like features. Instead of having individual accounts holding investments that fluctuate with market performance, each participant in a cash balance plan has a hypothetical account balance that grows in two ways:
- Pay Credits: The employer credits a certain percentage of the employee’s salary to their hypothetical account each year.
- Interest Credits: The account also grows based on a predetermined interest rate, which may be tied to a market index, or be a fixed rate.
Because the employer guarantees the benefit, including the interest crediting rate, the risk and responsibility of investment performance reside with the employer, not the employee. This is a critical distinction.
Why Forfeitures Are Not Applicable
Since the employer is responsible for funding the promised benefit, there’s no concept of an employee “forfeiting” a portion of their benefit in the traditional sense. Even if an employee leaves the company before retirement, they are still entitled to the vested balance of their hypothetical account, calculated based on their years of service and the plan’s provisions.
The benefit is determined by the plan’s formula, regardless of employee turnover. The employer remains obligated to fund the plan adequately to ensure all promised benefits can be paid out, factoring in expected employee turnover rates.
Therefore, there is no need for a forfeiture account. The employer’s funding calculations already incorporate expected attrition and its impact on the overall cost of providing benefits.
Frequently Asked Questions (FAQs) about Cash Balance Plans and Forfeitures
Here are some frequently asked questions to help you understand the nuances of cash balance plans and how they differ from defined contribution plans with respect to forfeitures:
1. What Happens to the Funds if an Employee Leaves a Cash Balance Plan?
When an employee leaves a company with a cash balance plan, they are entitled to the vested portion of their hypothetical account balance. This balance can typically be taken as a lump sum, an annuity, or rolled over into another qualified retirement plan, such as an IRA or another employer’s plan. The specific options depend on the plan’s provisions.
2. How is Vesting Determined in a Cash Balance Plan?
Vesting in a cash balance plan is governed by the same rules as other defined benefit plans, which are generally more favorable than defined contribution plans. Many plans offer cliff vesting (100% vested after a certain number of years of service) or graded vesting (gradually vesting over time). The maximum vesting schedule allowed is typically either 3-year cliff vesting or 2-6 year graded vesting.
3. Can an Employer Reduce Contributions Based on Employee Turnover in a Cash Balance Plan?
No, not directly. An employer cannot reduce contributions in a specific year because of higher-than-expected employee turnover. Actuarial valuations for the plan will factor in assumptions about employee turnover in determining required contributions. If turnover is significantly higher than expected over the long term, it could affect future contribution rates, but not in a direct, year-to-year way like a forfeiture account in a 401(k) plan.
4. Does a Cash Balance Plan Have Any Unallocated Funds Similar to Forfeitures?
Not in the same way as a forfeiture account. Any actuarial gains or losses arising from differences between expected and actual experience (including employee turnover) impact the overall funding requirement of the plan, but are not specifically tracked in a separate account labeled “forfeitures.”
5. What Happens if a Cash Balance Plan is Terminated?
If a cash balance plan is terminated, all participants become fully vested in their hypothetical account balances, regardless of their prior vesting status. The plan assets must be sufficient to cover all accrued benefits. If there is a funding shortfall, the employer is responsible for making up the difference.
6. Are Cash Balance Plans Subject to the Same ERISA Rules as Other Pension Plans?
Yes, cash balance plans are subject to the same ERISA (Employee Retirement Income Security Act) rules as other defined benefit plans. This includes requirements for funding, reporting, disclosure, and fiduciary responsibilities.
7. How are Interest Credits Determined in a Cash Balance Plan?
The method for calculating interest credits is defined in the plan document. The rate can be a fixed percentage, tied to a specific market index (e.g., the yield on Treasury securities), or determined by some other objective formula. The interest crediting rate is guaranteed by the employer, regardless of market performance.
8. Are Cash Balance Plans Insured by the PBGC?
Yes, like other defined benefit plans, cash balance plans are generally insured by the Pension Benefit Guaranty Corporation (PBGC). The PBGC provides a safety net in case the employer is unable to fund the plan adequately. However, the PBGC coverage is subject to certain limitations.
9. How Does Funding Work in a Cash Balance Plan Compared to a 401(k) Plan?
In a cash balance plan, the employer is responsible for funding the plan based on actuarial calculations. These calculations take into account factors such as employee demographics, salary projections, and expected investment returns. In a 401(k) plan, the employer may make matching contributions, but the funding primarily comes from employee contributions. The employer’s funding obligation in a cash balance plan is generally more substantial and complex.
10. What are the Advantages of a Cash Balance Plan for Employers?
Cash balance plans offer several advantages for employers, particularly small and medium-sized businesses. They can provide more significant tax-deductible contributions than defined contribution plans, especially for older business owners. They also allow for predictable benefit costs and can be designed to attract and retain key employees.
11. How Can I Find Out More About My Company’s Cash Balance Plan?
Your company is legally obligated to provide you with a Summary Plan Description (SPD) that outlines the details of the plan, including eligibility requirements, vesting schedule, benefit calculation method, and distribution options. You can also request a copy of the full plan document from the plan administrator.
12. Is a Cash Balance Plan Right for My Business?
Deciding whether a cash balance plan is right for your business depends on several factors, including your company’s size, demographics, financial situation, and retirement plan goals. Consulting with a qualified actuary, financial advisor, and ERISA attorney is essential to determine if a cash balance plan is a suitable option. They can help you assess the potential benefits and drawbacks and ensure that the plan is properly designed and implemented to meet your specific needs.
In conclusion, while the concept of forfeitures is relevant in defined contribution plans like 401(k)s, it does not apply to cash balance pension plans. The employer’s responsibility for funding the promised benefits eliminates the need for a forfeiture account. Understanding the fundamental differences between these plan types is crucial for both employers and employees to make informed decisions about their retirement savings.
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