Although not a new design, there has been renewed interest in the “combo plan” as a way for higher income business owners to turbocharge their retirement savings. The term “combo plan” generally refers to the combination of a defined contribution plan (usually a 401(k) profit sharing plan) and a defined benefit plan (usually a cash balance plan). The combined benefits in both plans are tested together to allow certain owners or key individuals to receive significantly larger amounts without breaking the bank in contributions to the employees.
Sounds great, right? Sure, but there are several factors that are important to consider in determining whether the combo plan arrangement is right for you. Some of the concepts can be a little tricky, so we will take a look at them using an example.
Drs. Suffering, Pain, Agony and Misery have a medical practice—SPAM, PC. In addition to themselves, they have six employees and currently sponsor a cross-tested, safe harbor 401(k) profit sharing plan. Each of the doctors maximizes his or her deferrals. In addition to the 3% safe harbor contribution, the practice makes profit sharing contributions of 2% of pay to the employees (bringing the total to 5%) and enough for each of the doctors to reach the defined contribution plan maximum limit ($53,000 for 2015).
The SPAM doctors decide that they would like to contribute an additional $100,000 per year each, so they call their TPA/actuary to find out if that is possible. Enter the combo plan as the possible solution.
As noted above, the defined benefit part of the equation is usually what is called a cash balance plan. It is important to remember that a cash balance plan is a defined benefit plan in every way. That means it is subject to all the regular defined benefit rules, including annual funding requirements, actuarial valuations, etc.
The key difference is in the way the benefit is expressed—in the form of a guaranteed “hypothetical account” rather than what can be perceived as an esoteric formula based on years of service and average compensation. The hypothetical account is adjusted annually for guaranteed contribution credits and interest credits, both of which must be specified in the plan document.
Another reason cash balance plans have become the go-to is that they provide “age-neutral” benefits which reduces volatility. Older employees do not require higher contributions than younger employees which is one of the disadvantages of a traditional defined benefit plan.
Based on this information, our friends at SPAM decide to go with a cash balance plan. In addition to how the assets are invested, there are several critical decisions the doctors must make that will determine the levels of overall contributions:
- Who is eligible for/who will be covered by the plan?
- How will interest be credited to participants’ hypothetical accounts?
- What benefit levels are desired and/or required to pass all the nondiscrimination tests?
All defined benefit plans are subject to a minimum participation test, which requires at least 40% of the eligible participants receive a “meaningful” benefit. There are two exceptions: no more than 50 participants have to receive it; and if there are at least two eligible participants, they both must receive it. Let’s look at several examples:
- SPAM has 10 eligibles: At least 4 must receive meaningful benefits.
- Company B has 200 eligibles: At least 50 must receive meaningful benefits from the defined benefit or cash balance plan.
- Company C has 2 eligibles: Both employees must receive meaningful benefits.
Sometimes the cash balance plan is designed with various job classes excluded. For example, if SPAM excludes all job classes other than doctors, the plan would cover 40% of their eligible employees and pass the minimum participation test.
The challenge is that this can create volatility in small companies. Let’s say the SPAM cash balance plan covers only the doctors, which obviously appeals to them. In year two, they increase their staff to 11 or 12, which means one additional employee must be brought into the cash balance plan. Now, one of the main selling features for the plan, that it only covers the doctors, has already fallen apart. It can also be difficult to explain to employees why some of them are covered in a second plan while others are not.
OK, by now you must be asking yourself, “So what’s a meaningful benefit?” There is no formal guidance on this, but the IRS takes the position it is meaningful if it provides a benefit at retirement of at least 0.5% of compensation.
In a cash balance plan this does not mean a current contribution credit of 0.5% of compensation is meaningful! Rather, it must be accumulated to retirement and converted to a benefit for this test, so the amount it takes to be meaningful depends on the age and salary of the employee. For a young, lower-paid employee, a credit of $750 may be meaningful but for an older, very highly-paid employee it might take $10,000.
You will need to decide what interest crediting rate to select for the plan, which is an issue that warrants an entire article all on its own. In the interest of brevity, suffice it to say that it should tie into the trustees’ investment policy, tolerance for volatility and losses and understanding of some of the more advanced options available. Often in small combo plans like that of SPAM’s, a low flat crediting rate of 3%–5% is used, and the trustees will invest the funds fairly conservatively to avoid the possibility of large losses.
The SPAM doctors have decided the cash balance contribution credits will be $100,000 for each doctor and $1,000 to each of the other six participants. Sounds simple…what else is there to discuss? Lots, actually.
One of the first things to understand is that the cash balance plan will never be able to satisfy the nondiscrimination requirements on its own. It is part of a combo plan design, after all, so it will have to rely on contributions for the six employees in the profit sharing plan to pass.
The TPA/actuary accumulates the cash balance credits and the profit sharing allocations to retirement, converts them to benefits, compares them to salaries and tests them to confirm they are not discriminatory. That means those profit sharing contributions for the staff become required as long as the cash balance plan exists.
There is also a special “gateway” requirement that requires the staff to receive a minimum combined contribution of between 5%–7.5% of salary. In the typical combo plan the gateway usually translates to a required profit sharing contribution for the staff of about 6%–7% of pay. This only works if the staff, on average, is younger than the principals who are receiving the higher amounts.
In most cases a combo plan for a small group will be top heavy (meaning that more than 60% of the combined benefits are for the owners and officers), and that triggers certain minimum contribution requirements. It is always best to provide this minimum in the profit sharing plan, which amounts to 5% of pay. Since the gateway amount already exceeds 5%, using this approach is a no-brainer as they say.
Another government agency, the Pension Benefit Guaranty Corporation, oversees certain aspects of defined benefit plans; however, plans sponsored by professional organizations like SPAM, who have fewer than 25 employees, are generally not subject to that oversight.
Plans covered by the Pension Benefit Guaranty Corporation do not have any additional limits on the tax deductions they can take for plan contributions, but those not covered are subject to a special combo plan deduction limit. It can get a bit complicated, but here is the gist:
- If the aggregate profit sharing contribution exceeds 6% of pay, then the combined cash balance and profit sharing contribution the company can deduct cannot exceed 31% of pay.
- If the profit sharing does not exceed 6%, there is no combined limit.
Back to SPAM. Given the size of the cash balance credits being provided to the four doctors, the design cannot work if constrained by the 31% deduction limit. That means the total profit sharing contribution cannot exceed 6% of pay. However, since the profit sharing contribution to the staff may be 7% of pay or more, the doctors must receive less than 6% in order to keep the aggregate amount at the overall 6% limit.
Because of this dynamic a combo plan design can only work if the profit sharing plan allows for different levels of allocations by group or by individual participant.
There are a couple of defined benefit myths that need to be dispelled:
- Once the plan is set up the contribution amount can’t be changed.
- The plan must exist for at least five years or could be disqualified.
Both of these statements are incorrect. A defined benefit plan can be amended at any time (even in year two) to decrease or freeze the benefit. But as with any defined benefit plan, this amendment can only be made prospectively, before the credit has already been accrued for the year.
One of the requirements for any qualified plan is that the intention has to be that the plan is permanent at the time it is established. This does not mean a plan cannot be terminated within a few years if the business is sold, the principals get sick, the economy goes into recession, etc. It just means that when the plan is set up, the sponsor should intend for it to be permanent. This is why you will hear the mantra that the plan should exist for five years.
While there is flexibility to amend a defined benefit plan prospectively, you do not have discretion as to whether you make a contribution in a given year like you do with a stand-alone profit sharing plan. There will be a minimum amount that must be contributed each year. The actuary will calculate this amount, and failure to make the contribution timely results in some potentially expensive excise taxes payable to the IRS.
There are many different ways to design combo plans and not every client will be as straightforward as our friends at SPAM, PC. The important thing is to always convey your specific objectives to your TPA and then for them to design the simplest, most stable plan that meets those objectives.
This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.
We’re leaders in retirement plan administration.
How can we help you get where you want to go?
Phone: (732) 747-1540
Email: [email protected]
Spring will arrive soon, promising new growth and a fresh beginning. It could also be the perfect time to do some spring cleaning for your plan. Let’s look at some areas that you might consider reviewing to ensure your retirement plan is operating efficiently.
Document your processes and procedures to make certain that plan tasks can be handled in case of any absences during an enrollment or pay period. Having a backup in place can prevent errors and delays that could lead to penalties.
Make sure to have a process in place to notify all new enrollments of their eligibility, regardless of whether the plan has automatic enrollment. Depending on the timing for plan entry, including the plan enrollment paperwork with the new hire paperwork could make entry easier for you. Please reach out with any questions regarding when an employee enters the plan.
Deposits of employee deferrals and loan repayments must be submitted to the plan as soon as possible to avoid penalties and corrections. For plans with less than 100 participants, a safe harbor rule allows deposits to be made within seven business days. For larger plans, the expectation is that the money will be deposited more quickly. Depositing these funds on the pay date will avoid the possibility of being late.
Monitoring deferral contribution limits during the calendar year will avoid refunds after year end. Make sure that your payroll is set up to stop deferrals once the limit is reached, including any catch-up contributions for those who have reached age 50.
To keep the plan in compliance, employer contributions must be deposited timely. Due dates are impacted by the type of contributions, required status and tax deductibility. If you have questions on when to deposit your employer contribution or even whether to make an employer contribution, please contact us.
Most plans must be covered by a fidelity bond. The minimum coverage is 10% of plan assets (rounded up to the next $1,000) and the maximum coverage is $500,000. Additional requirements apply to plans with employer securities or non-publicly traded assets. If your fidelity bond is insufficient, now is the time to raise the coverage. Inflation clauses that increase the bond amount as the plan assets increase can ensure that your bond coverage is always adequate. Contact us or your insurance provider if you don’t have a fidelity bond.
Another area to review is communication with participants. Helping your employees understand and trust the plan can increase their contributions. Be sure that your procedures include distributing any plan-related communications—including required participant notices.
Distributions also involve communication, including some of the aforementioned notices. Discussing distribution options with terminated participants, possibly as part of an exit interview, can help to reduce risk of lost participants. We’ll provide instruction on distributions for force-out distributions for small balances, testing corrections and required minimum distributions.
Your plan document is the legal source on how the plan should be administered; operating within its parameters is critical. It’s always worth taking time to review the plan document to ensure that you fully understand and are following its provisions. We’ll cover more details about the plan document later in this newsletter. We’re here to support you in keeping your plan in compliance. Please feel free to reach out with any questions.
Addressing the Challenge of Uncashed Distribution Checks
Uncashed distribution checks present a persistent and often overlooked challenge for retirement plan sponsors. Despite the best efforts of plan administrators, some participants fail to cash their distribution checks, leading to administrative burdens, fiduciary concerns and potential compliance issues. A recent publication by Retirement Management Services (RMS) sheds light on this issue and offers practical guidance for employers seeking to manage and mitigate the risks associated with uncashed checks.
Uncashed checks can arise for various reasons. Participants may have moved without updating their contact information, may not recognize the check as legitimate or may simply forget to deposit it. Regardless of the cause, the responsibility for addressing these uncashed funds ultimately falls on the plan sponsor. This creates a fiduciary obligation to act in the best interest of the participant while ensuring compliance with IRS and Department of Labor (DOL) regulations.
Sponsors are encouraged to maintain up-to-date contact information for all plan participants and to follow up promptly when checks remain uncashed. This may involve sending reminder letters, making phone calls or using certified mail to confirm receipt. In some cases, plan sponsors may also consider using electronic payment methods to reduce the likelihood of checks going uncashed in the first place.
The IRS and DOL have issued guidance on how to handle these situations, including the use of forfeiture accounts and escheatment to state unclaimed property programs. However, these options come with their own set of rules and potential pitfalls. For example, using a forfeiture account may require the plan document to explicitly allow for such treatment. Escheatment laws, which allow the government to assume control of unclaimed property, vary by state. As such, plan sponsors must carefully evaluate their options and consult with legal or compliance experts as needed.
Another important consideration is the documentation of all the efforts made to contact participants and resolve uncashed checks. Maintaining a clear audit trail can help demonstrate fiduciary prudence and protect the plan sponsor in the event of an audit or legal challenge. It is extremely important to have a written policy in place that outlines the steps to be taken when a check remains uncashed beyond a certain period.
By taking a proactive, well-documented and compliant approach, employers can fulfill their fiduciary duties, reduce administrative burdens and ensure that participants receive the benefits they are entitled to.
Source: Retirement Management Services – “Uncashed Distribution Checks” https://www.consultrms.com/Resources/59/Plan-Sponsor-Tips-and-Help/212/Uncashed-Distribution-Checks
Divorce and the Retirement Plan
When a participant in a qualified retirement plan undergoes a divorce, the participant’s account balance may be an asset that is split with the former spouse. As the plan exists for the exclusive benefit of its participants, a court order is required to transfer the participant’s benefits to the ex-spouse. Once approved by the plan administrator, this court order is called a Qualified Domestic Relations Order (QDRO).
The QDRO is a judgment, decree or order that must be issued by a state authority (usually a court). It can be part of the divorce settlement or it may be a separate document. Because of the serious nature of separating the participant’s account balance, the QDRO is more than just an agreement made by both parties — it must also be signed by a judge.
A QDRO will describe how to divide the participant’s account balance between the participant and the ex-spouse, referred to as the alternate payee. In some cases, a set dollar amount will be allocated; in others, a percentage of the account may be designated. In the latter case, the amount assigned to the alternate payee represents the given percentage of the participant’s total vested account balance as of a specified valuation date. This percentage will apply to all sources — such as deferrals, matching or profit sharing — unless specified by the QDRO. Any interest and investment gains/losses that accrue between this valuation date and the date the funds are separated into an account for the alternate payee are often factored into this final calculation. If the participant has outstanding loans, the QDRO will usually indicate how the loans are handled.
Contributions such as deferrals and employer matching made after the valuation date are credited to the participant’s account. Earnings and losses are applied to the account balances. Once the division is complete, the alternate payee’s portion (either dollars or shares) is transferred to an account in the alternate payee’s name.
If the plan allows, the alternate payee may be paid out in a cash or rollover distribution. Not all plan documents allow the alternate payee to receive a distribution before reaching normal retirement age, so it’s important to follow the terms of the plan. In addition, the QDRO cannot violate the provisions of the plan document by requiring a plan to provide an alternate payee or participant with any type or form of benefit not otherwise provided under the plan.
Although the most common situation for a QDRO is a divorce, it can be issued in other situations, such as to a dependent in the case of child support. If the alternate payee is a minor child or legally incompetent, the order can also require payment to the individual with legal responsibility for the alternate payee. If a participant or their attorney provides you with a copy of a divorce decree that references the plan or a QDRO, please contact us immediately, and we will work with you to ensure it meets the requirements of the plan.
Important note for defined benefit plans: For 2025 plan years, PBGC premiums are due one month earlier than usual, specifically on the 15th day of the ninth month after the beginning of the plan year. For calendar year plans, this means the premium is due on September 15, 2025, instead of the usual October 15. This accelerated deadline is due to a provision in the Bipartisan Budget Act of 2015.
Upcoming Compliance Deadlines for Calendar-Year Plans
© 2025 Benefit Insights, LLC. All Rights Reserved.
© 2026 Red Bank Pension Services. All rights reserved. Website by GSM Marketing