What is a Cash Balance Plan?

A Cash Balance plan is a modern twist on the traditional pension, designed to offer a blend of security and flexibility. It’s a type of defined benefit plan, meaning that the employer promises a specific retirement benefit amount, but it stands out due to its unique account structure that resembles the individual accounts seen in 401(k) plans [1] [2].

At its core, a Cash Balance plan credits a participant's account each year with two key components: a "pay credit" (a percentage of the participant’s salary or a fixed dollar amount) and an "interest credit" (which could be a fixed rate or tied to an index like the Treasury rate) [3]. These credits accumulate over time, building up a balance that employees can see and track, much like they would in a 401(k). However, the balance is hypothetical, as it's really a bookkeeping entry rather than an actual account holding assets in the participant's name [4].

One of the primary benefits of a Cash Balance plan is that it provides a clear and predictable retirement benefit. Unlike traditional pensions, where the benefit is often calculated based on a complex formula tied to years of service and final salary, a Cash Balance plan’s benefit is more straightforward. Employees can see their account grow year by year and know what they’re on track to receive at retirement. Moreover, since the plan is a defined benefit plan, the investment risk falls entirely on the employer. Regardless of how the plan's investments perform, employees are guaranteed the promised interest credit and eventual payout [5].

For employers, Cash Balance plans offer a way to provide meaningful retirement benefits while maintaining more predictable costs. The interest crediting rate is pre-determined, which helps employers manage their financial obligations more effectively. Additionally, Cash Balance plans can be particularly advantageous for older employees who may not have had the chance to save much in a 401(k) but can benefit significantly from the higher contribution limits of a defined benefit plan [2].

Upon reaching retirement, participants in a Cash Balance plan can usually choose between receiving their benefit as a lifetime annuity or as a lump-sum payment. The annuity provides a steady income stream for life, while the lump sum offers the flexibility to roll the money into an IRA or another retirement account, where it can continue to grow [3].

In summary, a Cash Balance plan is an innovative retirement option that combines the best features of traditional pensions and defined contribution plans like 401(k)s. It offers the security of a guaranteed benefit with the transparency and flexibility that today’s employees often seek in their retirement planning [1] [4].

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References

[1] U.S. Department of Labor. (n.d.). Fact Sheet: Cash Balance Pension Plans. Retrieved from https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/fact-sheets/cash-balance-pension-plans 

 [2] Journal of Accountancy. (2023, January 1). The rise of the cash balance pension plan. Retrieved from https://www.journalofaccountancy.com/issues/2023/jan/rise-of-the-cash-balance-pension-plan.html 

 [3] U.S. Department of Labor. (n.d.). Frequently Asked Questions on the Cash Balance Pension Plans. Retrieved from https://www.dol.gov/sites/dolgov/files/EBSA/about-ebsa/our-activities/resource-center/faqs/cash-balance-pension-plans-for-employers.pdf 

 [4] Investopedia. (n.d.). Cash Balance Pension Plan: Overview, Pros and Cons, and FAQ. Retrieved from https://www.investopedia.com/terms/c/cashbalancepensionplan.asp 

 [5] Bureau of Labor Statistics. (n.d.). Cash Balance Pension Plans: The New Wave. Retrieved from https://www.bls.gov/opub/mlr/cwc/cash-balance-pension-plans-the-new-wave.pdf