Cash Balance Pension Plan

A cash balance pension plan (CBP) is a type of defined‑benefit retirement plan that presents benefits as an individual account balance rather than a guaranteed monthly payout. Employers credit each participant’s hypothetical account with a pay credit (a percentage of salary or a flat dollar amount) plus an interest credit. The employer bears the investment risk and is responsible for ensuring promised benefits are funded.

How it works

• Employer credits each participant’s account annually with:
• A pay credit (e.g., 5% of salary), and
• An interest credit, which may be a fixed rate (e.g., 5%) or a variable rate (often linked to a Treasury yield).
• The account balance is a bookkeeping construct reflecting those credits; actual plan investments are managed by the employer.
• At termination or retirement, the participant typically can choose:
• A lump‑sum distribution (which may be rolled into an IRA), or
• An annuity that converts the account balance into lifetime payments.
• Benefits and funding obligations are governed by defined‑benefit rules and protected under federal law (e.g., ERISA).

Example: If an employee earning $100,000 receives a 5% pay credit and a 5% interest credit, the account is credited $5,000 plus 5% interest on the existing balance for that year.

Cash balance vs. traditional pension

• Traditional defined‑benefit plans commonly calculate a monthly retirement benefit based on years of service and a final‑average or high‑salary formula.
• Cash balance plans state the promised benefit as an accumulated account balance, often making the benefit easier for employees to understand and portable if they leave the employer.

Cash balance vs. 401(k)

• Investment risk:
• Cash balance: employer bears investment and funding risk; the employer must deliver the promised benefit regardless of investment results.
• 401(k): employee generally bears investment risk; benefits equal the account balance at retirement.
• Contribution/accumulation:
• Cash balance plans are funded by the employer to meet projected retirement balances and do not follow the same annual deferral limits as individual 401(k) contributions—allowing much larger pretax accumulation, especially for older participants.
• 401(k) contributions are limited by IRS annual caps and often include employee contributions and employer matches.
• Portability and flexibility:
• Cash balance plans offer lump sums that can often be rolled into IRAs or other plans, similar to 401(k) rollovers.

Pros and cons

Pros
* Predictable employer‑funded benefit with guaranteed credits.
* Lump‑sum option at termination or retirement, which can be rolled into an IRA.
* Tax‑deferred accumulation—taxes are paid upon distribution.
* Customizable contribution amounts—employers can structure higher contributions for older or key employees.

Cons
* Employer bears funding and investment risk; administrative and actuarial costs are higher.
* Typically no employee salary deferrals—employees cannot add to the plan from wages.
* Distributions are taxable upon withdrawal.
* Complexity in setup and ongoing compliance compared with simpler defined‑contribution plans.

Special considerations

• Interest credits can be fixed or variable (often tied to long‑term Treasury rates).
• Cash balance plans are usually more expensive to start and maintain due to actuarial valuations, funding requirements, and administrative fees.
• Employers sometimes offer a cash balance plan alongside a 401(k); combined, contributions for rank‑and‑file employees may be somewhat higher than a 401(k) alone.
• Vesting rules determine how much of the account a departing employee can take; vested balances can generally be rolled into an IRA or another employer plan.

Common questions

Q: Is a cash balance plan better than a 401(k)?
A: “Better” depends on goals, income, time horizon, and whether you value employer‑funded, predictable credits (CBP) or control and portability of your own investments (401(k)). High‑earners and older employees often benefit most from cash balance plans.

Q: What can I do with the lump sum?
A: You can take it as cash (taxable), roll it into an IRA or another qualified plan, or convert it to an annuity if the plan allows.

Q: What happens if I leave my job?
A: You can take the vested portion of your cash balance plan with you—typically as a lump sum or annuity option—and often roll it into an IRA or a new employer’s plan.

Bottom line

A cash balance pension plan blends features of defined‑benefit and defined‑contribution plans: benefits are expressed as account balances with employer funding and guaranteed credits. It can be a powerful retirement vehicle—especially for older or highly compensated employees—but involves greater employer cost and complexity. Evaluate how a cash balance plan fits your retirement goals, expected tax situation, and employment horizon before deciding whether to participate or implement one as an employer.