Cash Balance Plans: A Hybrid Approach to Retirement Savings

A Cash Balance Plan is a type of employer-sponsored retirement plan that combines elements of both defined benefit and defined contribution plans. Unlike traditional defined benefit plans, where the retirement benefit is determined by a formula based on salary and years of service, Cash Balance Plans define benefits in terms of individual account balances. Each employee has a hypothetical account that grows annually based on a specified interest crediting rate and contributions determined by the employer.

• Hypothetical Accounts: In a Cash Balance Plan, each employee has a hypothetical account that is credited with contributions from the employer and interest. Employees can see their balance grow over time, making it feel more like a savings account than a traditional pension.

• Interest Crediting Rates: The plan specifies how much interest will be credited to the account each year. This can be a fixed rate or linked to an external index.

• Benefit Distribution: Upon retirement or termination of employment, employees can receive their benefits as a lump sum or in annuity form, providing flexibility in how they access their retirement savings.

The popularity of Cash Balance Plans has surged in recent years, particularly among small to mid-sized businesses. This trend can be attributed to several factors:

• Hybrid Structure: Employers appreciate the hybrid structure, which combines the predictability of a defined benefit plan with the transparency of a defined contribution plan.

• Tax Advantages: Cash Balance Plans allow for higher contribution limits compared to traditional 401(k) plans, making them an attractive option for businesses looking to maximize tax-deferred savings.

• Attracting Talent: Offering a Cash Balance Plan can help businesses attract and retain talent by providing a robust retirement benefit that aligns with employee expectations.

• Traditional Cash Balance Plan: This is the most common type, where employers make annual contributions to employee accounts based on a predetermined formula.

• Portable Cash Balance Plan: This type allows employees to take their benefits with them if they change jobs, enhancing the plan’s appeal to a mobile workforce.

For instance, consider a small technology firm that implements a Cash Balance Plan. The firm may decide to contribute a percentage of each employee’s salary to their hypothetical accounts, with a guaranteed interest rate of 4%. This means that an employee earning $100,000 would see their account grow by $4,000 each year, in addition to the employer contributions.

• Integration with 401(k) Plans: Many companies choose to offer both Cash Balance Plans and 401(k) plans, allowing employees to benefit from both types of retirement savings vehicles.

• Funding and Investment Strategies: Employers must carefully plan how to fund these plans, often relying on conservative investment strategies to ensure they can meet their future obligations.

In conclusion, Cash Balance Plans are a unique retirement savings option that offers a blend of benefits from both defined benefit and defined contribution plans. With their growing popularity, particularly among small businesses, they provide an attractive solution for employers looking to enhance their employee benefits package while also maximizing tax advantages. Understanding the components, trends and strategies associated with Cash Balance Plans can help you make informed decisions about retirement planning, whether you are an employer or an employee.