Cash Balance Plans

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A Cash Balance Plan is a Defined Benefit Plan that looks like a Money Purchase Plan. Like a Money Purchase Plan, fixed contributions are credited to each participant at the end of each year.

In addition, participants receive interest credits based on the interest rate defined in the plan. The credit is a fixed rate specified in the plan. Increases or decreases in the value of the plan’s investments do not directly affect the benefits promised to the participants. The investment risks and rewards are borne solely by the employer.

The plan maintains a hypothetical account balance for each participant. When the participant retires, his benefit is the value of the hypothetical account. This lump sum value can be converted to a monthly pension at retirement.

A Cash Balance plan appears to participants as a Defined Contribution Plan but is treated under the Internal Revenue Code as a Defined Benefit Plan. Participant statements look like a Defined Contribution Statement in that they will reflect the following:"

  • Beginning Balance
  • Contribution Credits
  • Interest Credits
  • Ending Balance

Can a Cash Balance Plan be combined with a 401(k) Profit Sharing Plan?

To produce larger contributions, especially for Principals and Owners, Cash Balance Plans are usually combined with 401(k)/Profit Sharing Plans. The 401(k) and Profit Sharing component can also provide flexibility in the combined plan.

How are investments in a Cash Balance plan managed?

Assets in the plan are not allocated to participants. Participants cannot direct the investments. The pooled fund is invested by the Trustees and Investment Advisers. Gains or losses from investments will reduce or increase the Plan Sponsor’s contribution. Since interest credit guarantees cannot exceed market rate of return, assets may be invested conservatively.

What are the other features of the Cash Balance Plan?

When a participant becomes entitled to receive benefits under a cash balance plan, the benefits are defined in terms of an account balance. For example, assume that a participant has an account balance of $100,000 when he reaches age 62. If the participant decides to retire at that time, he would have the right to an annuity based on his account balance. Such an annuity might be approximately $10,000 per year for life. In many cash balance plans, however, the participant could instead choose (with consent from his spouse) to take a lump sum benefit equal to the $100,000 account balance.

Is the plan flexible?

No is the most common answer as flexibility is dependent on required testing. Any changes in allocation rates require a plan amendment. It is recommended for plan sponsors to provide a commitment to this type of plan of at least five years.

PBGC Insurance Premiums

In general, the benefits in Cash Balance Plans are insured by the Pension Benefit Guaranty Corporation (PBGC); however, if the company is a professional service firm with fewer than 26 active participants, the plan is not covered by PBGC. Plans that are covered by PBGC insurance must pay a premium to the PBGC each year ($69 per participant starting in 2017). If plan investments do not perform adequately or the plan sponsor chooses to make less than the recommended contribution, the plan could have unfunded benefit liabilities. Unfunded benefit liabilities will increase the amount of premium that must be paid.

Published in Retirement

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