Course: Retirement Planning
Lesson 4: Understanding Types of Qualified Plans
I have studied the material in depth, but am still struggling with the distinction between Money Purchase Plans, Cash Balance Plans, and Target Benefit Plans. I have read all of the notes and think I have it and then get a question and confusion sets in
Can you provide a few sentences on how you think of them in practice?
Great question. These can be confusing. Please see my notes below, and let me know if you have any questions.
Applications for Money Purchase Plan
- Plan sponsor makes fixed annual contributions to participants
- Fixed amount can change, but only prospectively (can change next year’s contribution rate but not this year’s)
- Offers less sponsor-contribution flexibility than Profit Sharing Plan or 401(k) Plan
- Less popular than Profit Sharing Plan or 401(k) Plan
Applications for Cash Balance Plan
- Conversion of Defined Benefit to Cash Balance Plan
- Plan sponsor no longer willing to accept investment risk
- Overfunded Defined Benefit plan conversion to Cash Balance – no
penalty if all excess Defined Benefit plan funding transfers to Cash
- Employer can use excess DB funding to make employer contributions to Cash Balance plan
- Adopt Cash Balance Plan
- Sponsors wishes to fund for past service but not willing to accept investment risk of a Defined Benefit plan
Applications for Target Benefit Plan
- Was once one of few methods to discriminate in favor of older participants regarding plan contributions
- Cross-testing in Profit Sharing plans and profit-sharing component of 401(k) plans are more effective ways to get more $$ to older participants.
- Hence, Target Benefit plans not as popular as in years past.