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What is a cash balance plan?
A cash balance plan is a defined benefit retirement plan that expresses the retirement benefit in terms that are more characteristic of a defined contribution plan; for example a profit sharing plan. In other words, a cash balance plan communicates the promised benefit to employees as an account balance rather than an annual amount payable for life.
How does a cash balance plan work?
Each participant has a notional account that resembles that of a 401(k) or profit sharing plan. This account is credited with contribution credits and interest credits each year. The contribution credit is defined in the plan and is typically set as a percentage of pay (for example 4% of compensation) while the interest credit is either a fixed rate or variable rate linked to an index such as the Five-year Treasury Constant Maturities plus 25 basis points (0.25%).
How much can be contributed in a cash balance plan?
The actual employer contribution is determined by a formula specified in the plan document. It can be a percentage of pay or a flat dollar amount. The table below illustrates the typical contribution limits for various age groupings.
Age | 401(k)/PS | Cash Balance | Total | Tax Saving* |
60-65 | $54,500 | $209,000 | $263,500 | $105,400 |
55-59 | $54,500 | $164,000 | $218,500 | $87,400 |
50-54 | $54,500 | $125,000 | $179,500 | $71,800 |
45-49 | $49,000 | $96,000 | $145,000 | $58,000 |
*Assuming 40% tax bracket, taxes are deferred
How is the cash balance plan similar to a pension plan?
- Provides retirement benefits based on a stated formula.
- Actuarial calculation of contributions and certifications.
- Annuity benefits must be offered as an option to the participant.
- Benefits are guaranteed by the Pension Benefit Guaranty Corporation (PBGC).
- Participants’ benefits are not affected by the actual investment return of the trust.
How is the cash balance plan similar to a defined contribution plan?
- A notional account is created for each participant. This accounting format makes it easier for most people to understand the plan.
- Contribution credits can be tracked directly to the ultimate benefits paid.
- The account balance is portable upon an employee’s separation from service, and can be rolled into an IRA account.
- The cash balance plan may have a 3 year vesting schedule which is more similar to a defined contribution plan and more rapid than that of a traditional defined benefit plan.