Cash Balance plans are a type of defined benefit plan that includes some elements that are similar to a defined contribution plan because the benefit amount is computed based on a formula using contribution and earning credits, and each participant has a hypothetical account.
Cash Balance plans are more likely than traditional benefit plans to make lump sum distributions.
Cash Balance explained
A cash balance pension plan is a defined benefit pension plan with the option of a lifetime annuity. The employer credits a participant’s account with a set percentage of their yearly compensation plus interest charges for a cash balance plan. The funding limits, funding requirements, and investment risk are based on defined benefit requirements. Changes in the portfolio do not affect the final benefits received by the participant upon retirement or termination, and the company bears all ownership of profits and losses.
A cash balance plan is maintained on an individual account basis, much like a defined contribution plan. This means it isn’t like the regular defined benefit plan. Instead, the cash balance pension plan acts just like a defined contribution plan because changes in the value of the participant’s portfolio do not affect the account balance promised by the employer. The features of cash balance pension plans resemble those of 401(k) plans. Investments are managed professionally, and participants are promised a specific benefit at retirement. However, the benefits are stated in terms of a 401(k)-style account balance rather than the terms of a monthly income stream.
For example, an employee in a cash balance pension plan might receive a promise of 5% of their salary with a 5% interest credit. If they made $100,000 annually, they would receive a pay credit of $5,000 plus 5% interest paid on the account balance. As the number of years at the employer increases, the account balance grows to meet the balance promised by the company. At retirement, the employee can choose a lump sum or monthly annuity payment.
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