A cash balance plan is a type of defined benefit (DB) plan that looks and feels like a defined contribution (DC) plan, such as a profit sharing plan. Because of this, cash balance plans are considered “hybrid” plans.
Like a DC plan, each participant in a cash balance plan has an account that grows over time with employer contributions (Pay Credits) and interest (Interest Credits). When the participant leaves employment, he or she walks away with whatever vested account balance they have accumulated.
There are some important differences between cash balance plans and DC plans, though:
- In a cash balance plan, Pay Credits are defined in the plan document. For example, some participants may have a Pay Credit that’s a flat dollar amount (e.g. $100,000 per year), and others may have a Pay Credit that’s a percent of pay (e.g. 2% of pay). This differs from a DC plan, in which the plan sponsor has a fair amount of flexibility in what to contribute each year.
- In a cash balance plan, Interest Credits are also defined in the plan document. These Interest Credits can be defined as a flat percentage (e.g. 4% per year), tied to a benchmark (e.g. 10-year Treasuries plus 100 basis points), or more exotic definitions.
- Since Interest Credits typically aren’t tied directly to actual investment returns, the account balances in a cash balance plan don’t always exactly match up to the invested plan assets. For that reason, we sometimes refer to them as hypothetical balances.
- Since a cash balance plan is a type of DB plan, the contributions can often be much larger than in a DC plan; in some cases, $200,000 or more per year.
Since cash balance plans can easily define contribution levels for each participant, they work well in partnership situations where different partners have different savings goals. For example, one partner can target $150,000 annual contributions, another can target $60,000, and another $0. Also, combining a cash balance plan with a DC plan can help minimize benefit costs for non-owner employees.
For more information on Cash Balance Plans, visit our Cash Balance Plan FAQ page.