Financial Planning For The Elderly – Pension plans are fading in corporate America: In 1998, 59 percent of Fortune 500 companies offered them to new hires, but in 2015, only 20 percent did. Conversely, some law, medical, accounting and engineering firms maintain the spirit of a traditional retirement plan by adopting cash-based budget plans.
Owners and partners of these highly profitable businesses sometimes start their retirement planning late. Cash balance plans give them a chance to catch up. Contributions to these defined benefit plans depend on your age—the older you are, the more you can save for retirement each year. In 2016, a 55-year-old could set aside up to $180,000 a year in a cash budget plan; Age 65, up to $245,000.
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These plans are not for every business because they require significant contributions from the plan sponsor. However, they can prove to be less expensive to a business than a traditional pension plan and offer significantly more funding flexibility and employee benefits than a defined contribution plan such as a 401(k).
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How is a cash balance plan different from a traditional retirement plan? In a cash budgeting plan, the business or professional practice maintains an account for each employee with a hypothetical salary receivable (such as employer contributions) plus a “balance” of interest credits. There must be no discrimination in favor of senior members, managers or employees; the owner or owners must be able to make contributions for other employees as well. The plan pays the member a monthly pension-style income stream at retirement: a fixed dollar amount or a percentage of compensation. It is also possible to make one-time payments.
Each year, a plan member receives a salary credit equal to 5-8% of their compensation, plus an interest credit that is usually tied to the performance of a stock index or the return of a 30-year Treasury (investment credit can be variable or fixed). Cash balance plans are generally portable: the accumulated portion of the account balance can be paid out if the employee leaves before the retirement date.
As an example of how credits accrue, let’s say that employee Joe Green earns $75,000 per year at XYZ Group. Join the Cash Budget Plan, which provides a 5% annual salary credit and a 5% annual interest credit once the balance is available. Joe’s first-year salary credit would be $3,750 with no interest credit because his hypothetical account did not have a balance at the beginning of his first year of membership. In the second year (assuming no raise), Joe would receive another credit of $3,750 and an interest credit of $3,750 x 5% = $187.50. So at the end of two years of membership, your hypothetical account balance would be $7,687.50.
An employer assumes a significant responsibility with a cash balance plan. It must make annual contributions to the plan, and the actuary must determine a minimum annual contribution to keep the plan adequately funded. The employer actually bears the investment risk, not the employee. For example, if a plan says that members will be given a fixed 5% interest credit each year and performance doesn’t generate that much credit, the employer may have to put more into the plan to meet the promise. The employer and the financial professional who consults with the employer about the plan determine the investment choices, which are generally conservative.
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Employer contributions to the plan for a given tax year must be paid by the federal income tax due date for that year (plus extensions). Funding the plan before the end of the calendar year is eligible; the employer only needs to understand that any excess will be tax-free contributions. The plan must cover at least 50 employees or 40% of the company’s workforce.
Cash balance plans typically cost a business between $2,000 and $5,000 to set up and between $2,000 and $10,000 per year to run. It may sound expensive, but a cash budget plan gives owners the opportunity to keep the excess profits earned above the annual interest credit for employees. Another benefit is that cash balance plans can be used in conjunction with 401(k) plans.
These plans can be structured to adequately reward owners. When a traditional defined benefit plan uses a safe haven formula, key employees may receive more compensation than owners and managers would like. Cash balance plan formulas can correct this situation.
Benefit awards are based on career average pay, not just “best years.” In a traditional defined benefit plan, the benefit, if any, is based on an average of 3-5 years of the employee’s maximum salary multiplied by years of service. In the cash budget plan, the benefit is determined using the average of all salary years.
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Cash budget plans are less sensitive to interest rates than old-school retirement plans. As rates rise and fall, the liability in a traditional retirement plan fluctuates. This opens up opportunities for overfunding or underfunding (and underfunding is a big risk right now with interest rates so low). In contrast, there is relatively little change in the valuation of liabilities in the cash balance plan.
A cash balance plan cannot be administered with distraction. Must pass annual non-discrimination tests; it must be submitted for IRS approval every five years instead of every six. Obviously, a plan document needs to be developed and periodically amended, and there are the usual annual reporting obligations.
Ideally, the cash budget plan is managed by the company’s highly compensated employees (HCEs) who are in their early earning years. In terms of non-discrimination, the company must aim to achieve at least a 5:1 ratio: at least 1 HCE plan member for every 5 other plan members. In the best case scenario for a non-discrimination test, HCEs are 10-15 years older than half (or more) of the company’s employees.
If the worst-case scenario happens and the company goes out of business, cash budget plan members have some protection for their balances. Their benefits are insured up to a maximum value by the Pension Benefit Guaranty Corporation (PBGC). If a cash budget plan is terminated, plan members can receive the balance as a lump sum, roll the money into an IRA, or request that the plan sponsor roll over its liability to the insurer (retirement benefits are paid to the plan member through insurance). contract).
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Cash balance plans have become increasingly popular. Some companies have even adopted dual profit sharing and cash balancing plans. Maybe it’s time for your company to explore this intriguing alternative to the traditional pension plan.
Robert Pagliarini, PhD, CFP®, EA, is passionate about helping retirees build their dream retirement. He has more than 25 years of experience as a retirement financial advisor and holds a Ph.D. in retirement planning. Additionally, he is a CFP® Ambassador, one of only 50 in the country, and a true trustee. His focus is helping retirement portfolios last for decades, providing a steady source of income. When he’s not helping people plan for retirement, he’s writing his upcoming book, The Retirement Myth: Escape Average Retirement & Create a High Performance Retirement. If you would like a second opinion on whether your retirement financial plan will provide you with comfort and security, contact Robert today. Financial planning is important at any age. But for seniors, it means making sure they have the funds they need to enjoy retirement without the burden of financial stress. Here are some simple financial planning tips that seniors should follow to ensure that they are financially prepared for the changes that retirement may bring to their lifestyles.
According to a recent Gallup poll, the average retirement age in the US has risen to 62. But retirement at this age is not ideal for everyone. When deciding to retire, it is important to consider not only your age, but also your financial situation. Make sure all retirement plans are based on what you have saved and how many years you think your retirement savings will last.
Part of financial planning for seniors includes making sure you’re living within your means and accounting for expenses you may not have considered before, such as health care or long-term care costs. Take time to think through your budget and look for areas where you can cut unnecessary or frivolous costs. Downsizing to a smaller home or senior living community can also keep expenses down.
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One of the biggest mistakes seniors make when it comes to financial planning is not taking inflation into account. Today, the price of the product may increase until tomorrow. So make sure you have the funds you need to maintain a comfortable lifestyle not just today, but 10, 20 or even 30 years from now.
Most seniors today are eligible to receive Social Security benefits at age 62. But taking Social Security before the designated retirement age of 66 or 67, depending on the year you were born, could mean you’ll receive 25 percent less benefits than you expected. This is also important
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