CASH BALANCE PLANS

A cash balance plan is a defined benefit plan that resembles a defined contribution plan, but it really a hybrid. A traditional defined benefit plan promises a fixed monthly benefit at retirement, based upon a formula that considers the employee’s compensation and years of service. A cash balance plan is like a defined contribution plan because the employee’s benefit is expressed as a hypothetical account balance instead of a monthly benefit.

Each employee’s "account" receives an annual contribution credit, which is usually a percentage of compensation, and a specified interest credit based on a guaranteed rate or a recognized index like the 30-year treasury rate. At retirement, the employee’s benefit is equal to the sum of all contribution and interest credits. Although the plan is required to offer the employee the option of using the account balance to purchase an annuity benefit, employees generally will take the cash balance and roll it into an IRA (unlike many traditional defined benefit plans which do not offer lump sum payments at retirement).

The employer in a cash balance plan bears the investment risks and rewards. An actuary determines the contribution to be made to the plan, which is the sum of the contribution credits for all employees plus the amortization of the difference between the guaranteed interest credits and the actual investment earnings/losses. Employees appreciate this design because they can see their "accounts" grow but are still protected against fluctuations in the market, and is more "portable."