Cash Balance Plan FAQs

Cash Balance Plans

• What Is a Cash Balance Plan?

  A Cash Balance Plan is a Defined Benefit Plan has the look and feel of a Defined Contribution Plan. Some key differences between a Cash Balance Plan and a Defined Contribution Plan are that a Cash Balance Plan (1) provides stated rates of contributions and investment return, (2) often has higher tax-deductible contribution limits, and (3) may have required minimum contributions if it is not well-funded. Because it combines characteristics of different kinds of plans, a Cash Balance Plan is sometimes referred to as a Hybrid Plan. For more information on the differences between types of retirement plans, visit our Types of Plans page.

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• How does a Cash Balance Plan work?

  Each participant has a “hypothetical” account balance that grows each year with employer contributions (called pay credits) and interest credits. Account balances are referred to as hypothetical because there is really just one pooled account for all plan participants, but from the participant’s standpoint, there’s nothing hypothetical about it; the balance represents the benefit to which they are entitled.

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• How are Cash Balance Plans different from 401(k)/profit sharing plans?

  A Cash Balance Plan looks and feels like a 401(k) Plan from the participant’s standpoint. An account grows each year with employer contributions and interest. However, the plan assets are pooled and the Plan Trustee directs how the money is invested. Interest is guaranteed on participants’ accounts and may not necessarily follow the plan’s actual investment return on assets.

  The major difference from the employer’s perspective is that Cash Balance Plans have a required minimum contribution. Contributions are NOT discretionary, but like all Defined Benefit Plans will have a range of acceptable minimum and maximum contribution levels.

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• How are interest credits determined?

  Interest credits are chosen by the Plan Sponsor, are specified in the Plan Document, and can be either a flat amount or tied to an index (e.g. 10-year Treasury rates plus 100 basis points). Read a Special White Paper Issue of our Pension Trends Newsletter for a more in-depth analysis of the interest crediting options. Again, this is a key difference between Cash Balance Plans and 401(k)/profit sharing plans. No matter what the pooled assets earn, account balances grow at the specified interest credit rate.

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• What happens if investment returns don’t match the interest credit?

  To the extent that actual investment returns in a given year don’t match the interest credit defined in the Plan Document, participant accounts will become either Underfunded or Overfunded. The IRS will generally allow a Plan Sponsor to “let it ride” and see if actual returns in following years bring things back in line. However, most Plan Sponsors elect to true things up each year by adjusting the contribution. In other words, if actual returns fall short of the interest credit, they contribute a bit extra to make up the Shortfall, and vice versa.

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• How are plan assets typically invested?

  Because plan assets are pooled but account balances earn “guaranteed” interest credits, it is usually desirable for actual returns to match the interest crediting rate as closely as possible each year. Because of this, plan assets are typically professionally managed to ensure that the plan provides dependable, predictable levels of deductible contributions.

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• What happens when a participant terminates employment?

  A terminated participant can choose to roll over or take a cash distribution of their vested hypothetical account balance. Since a Cash Balance Plan is a type of Defined Benefit Plan, distributions are subject to the defined benefit rules. If the account balance is over a certain threshold (typically $5,000), the participant must also be given a choice of an Annuity form of payment.

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• When might a Cash Balance Plan be a good solution for my business?

  A Cash Balance Plan, especially when added on top of an existing 401(k)/profit sharing plan, is a solution that allows the business Owner(s) to substantially increase pre-tax savings. Business Owners who have dependably high levels of income, who may already have a 401(k)/profit sharing plan, and who would like to save more than about $60,000 per year on a tax-deferred basis are likely to benefit from a Cash Balance Plan.

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• Can the amount of benefit vary among partners, and between Owners and employees?

  Yes. A Cash Balance Plan can be designed with varying benefit levels, or “tiers”, for individual partners. For example, one benefit level could be $150,000 per year, another $100,000 per year, and another $0. Further, employees will usually participate at a much lower level than the business Owners (generally between 5% and 7.5% of pay).

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• Can benefit levels for participants be changed in the future?

  Yes. Although we recommend that benefit levels not be changed too frequently, a Cash Balance Plan can generally be amended to increase, decrease or even eliminate benefit levels for any or all participants. However, there are certain restrictions on lowering the interest crediting rate, so special consideration should be given to that selection prior to adopting the Plan Document.

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