Cash balance plans are a type of defined benefit pension plan that have gained traction among employers looking to provide robust retirement benefits while maintaining financial flexibility. They combine elements of traditional pension plans with features of defined contribution plans, making them a unique and attractive option for both employers and employees. This article provides an overview of cash balance plans, including their structure, benefits, regulatory considerations, and why they are becoming increasingly popular.
What Is a Cash Balance Plan?
A cash balance plan is a form of defined benefit plan that provides participants with a hypothetical account balance, which grows annually through employer contributions and an interest credit rate. Unlike traditional pensions, which promise a fixed monthly income upon retirement, cash balance plans express benefits as an account balance, making them more tangible and portable for employees.
Each year, the employer contributes a percentage of an employee’s compensation to the plan, and an interest credit (either a fixed rate or a variable rate that is tied to an index) is applied to the balance. Upon retirement or termination, employees can take their balance as a lump sum or convert it into an annuity. Additionally, cash balance plans differ from 401(k) plans in that investment risk is borne by the employer rather than the employee, helping to ensure more stable growth for participants.
Popularity and Growth Trends
Cash balance plans have been growing in popularity, particularly among small and mid-sized businesses, professional firms, and companies looking to enhance retirement benefits for high-earning employees. According to the most recent data:
- The number of cash balance plans has been steadily increasing over the past decade. According to FuturePlan’s 2023 National Cash Balance Research Report, cash balance plans now make up almost half of all defined benefit plans.
- Cash Balance plan assets exceed $1.2 trillion nationwide, including 9.4 million retirement plan participants.
- Many professional service firms, such as law and medical practices, have adopted cash balance plans due to their ability to provide substantial retirement savings for partners and owners.
- Companies with nine or fewer employees make up over 60% of all Cash Balance plans. Small business owners are drawn to these plans because of their ability to help catch up on delayed retirement savings as well as attract and retain top talent.
- The flexibility in contributions makes them appealing for businesses with fluctuating revenue streams.
Features for Employers
Employers benefit from cash balance plans in several ways:
- Tax Advantages: Contributions are tax-deductible, helping to reduce taxable income.
- Attract and Retain Talent: Offering a competitive retirement benefit can improve employee retention and recruitment.
- Flexibility in Contributions: Plans allow higher contributions compared to 401(k)s, especially for older employees, making them ideal for owners looking to accelerate their retirement savings.
- Predictability in Costs: Since the plan is employer-funded, businesses can manage liabilities better than with traditional pension plans.
- Potential for Profit Sharing: Employers can use these plans strategically for succession planning and profit distribution among key employees.
- Customizable Plan Design: Employers can tailor contribution levels and benefit structures to align with business goals and financial capabilities.
Features for Employees
Cash balance plans provide employees with a valuable retirement benefit, including:
- Higher Retirement Savings: Contributions and interest credits can potentially result in significantly higher balances than what’s possible in a defined contribution plan alone.
- Portability: Employees can roll over lump sum distributions into an IRA or another qualified plan when they leave the company.
- Predictable Growth: Interest credits offer a guaranteed rate of return, reducing investment risk.
- Security: Since the plan is a defined benefit plan, it is insured by the Pension Benefit Guaranty Corporation (PBGC), adding an extra layer of financial security.
- Simplified Retirement Planning: Employees don’t have to worry about managing investments, as the employer handles the plan’s funding and growth.
Regulatory Considerations
Cash balance plans are subject to specific IRS and Department of Labor regulations, including:
- Nondiscrimination Testing: Employers must ensure the plan benefits all employees fairly, not just highly compensated individuals.
- Contribution Limits: Maximum contributions depend on IRS rules and actuarial calculations, often allowing much higher savings than 401(k) limits.
- Vesting Schedules: Plans typically have a vesting period before employees are entitled to the full benefits.
- Required Annual Contributions: Unlike discretionary contributions in 401(k) plans, cash balance plans require consistent employer funding, making proper financial planning essential.
Key Considerations for Plan Sponsors
Before implementing a cash balance plan, employers should consider:
- Company Financial Stability: Cash balance plans require ongoing funding commitments, making them best suited for businesses with steady revenue.
- Employee Demographics: The plan should be structured to align with workforce needs and ensure compliance with nondiscrimination rules.
- Coordination with Existing Plans: Many businesses pair cash balance plans with 401(k) plans for optimal retirement savings strategies.
- Administrative and Actuarial Costs: These plans require actuarial services and compliance oversight, leading to higher administrative expenses compared to defined contribution plans.
- Long-Term Commitment: Since contributions are required annually, employers should assess their ability to maintain consistent funding over time.
Final Thoughts
Cash balance plans offer a powerful retirement savings vehicle for employers and employees alike. Their blend of defined benefit security with defined contribution flexibility makes them an appealing option for businesses seeking to maximize tax advantages, attract talent, and provide significant retirement benefits. Understanding their structure, benefits, and regulatory requirements is essential for plan sponsors looking to implement a cash balance plan successfully. With proper planning and administration, cash balance plans can serve as an effective tool for long-term financial security and workforce retention.
For plan sponsors looking to deepen their understanding of cash balance plans, the following resources can provide valuable insights and up-to-date information:
Informational Resources: FuturePlan by Ascensus: 2023 National Cash Balance Research Report; Investopedia: “Cash Balance Pension Plan: Overview, Pros and Cons” (September 2, 2024); Thrivent: “Cash Balance Pension Plans Explained” (December 18, 2024).