What is a cash balance plan?
A cash balance plan is a qualified employer-sponsored retirement plan that has become increasingly common in recent years as an alternative to (or replacement of) the traditional defined benefit pension plan. Though it is technically a form of defined benefit plan, the cash balance plan is often referred to as a "hybrid" of a traditional defined benefit pension plan and a defined contribution plan. This is because cash balance plans combine certain features of both defined benefit and defined contribution plans. Like traditional defined benefit plans, cash balance plans pay a specified benefit amount at retirement. However, like defined contribution plans, participants have individual (albeit hypothetical) accounts, allowing for easy tracking of accrued benefits.
Technical Note: A cash balance plan is a "statutory hybrid plan" that has a "lump-sum-based benefit formula."
Caution: The IRS issued final and proposed regulations in 2010 covering various cash balance plan requirements. The IRS subsequently delayed the effective date of those regulations. On September 19, 2014, the IRS issued new final regulations governing cash balance and other hybrid pension plans. While the new regulations are generally effective for plan years beginning on or after January 1, 2016, portions of the regulations that merely clarify provisions included in the 2010 final regulations are effective for plan years that begin on or after January 1, 2011.
What types of employers should consider a cash balance plan?
Almost any type of employer can adopt a cash balance plan or convert an existing traditional defined benefit pension plan to a cash balance plan. The following factors have contributed to the creation and recent growth of cash balance plans:
- Today's employees, especially younger ones, want to see benefits that reward them early in their careers, not mainly at the end. Younger employees also like the idea that there will be a longer period of time for their benefits to compound. As compared to traditional defined benefit plans, cash balance plans generally reward younger employees more substantially earlier in their careers and spread out the benefits more evenly during the rest of their careers.
- Women and men who have more career interruptions and shorter periods of employment often prefer this type of plan if they receive a higher benefit than with a traditional defined benefit pension plan.
- Employees want more portable benefits since job changes have become the norm, rather than the exception.
- Employees and employers prefer retirement plans that are relatively easy to understand in terms of the amount of retirement benefits.
If these factors describe many of your employees, you may want to consider adopting (or converting to) a cash balance plan. On the other hand, cash balance plans should be considered very carefully where employers have a large number of older, highly compensated employees who have been with the company for a long time. As discussed later, such employees may perceive more value in a traditional pension plan than in a cash balance plan.
Also, before you decide to establish a cash balance plan or convert an existing defined benefit pension plan, you also need to consider:
- The age, sex, salary, and retirement age of the participants
- The projected future costs of the plan
A cash balance plan puts certain obligations on the employer. When you establish this type of plan, you are making an ongoing commitment for pension contributions. You, not the employees, are taking on the risk of investment performance. If the plan investments do not perform as expected, it will be your obligation to make up any shortfalls.
The information in this newsletter is not intended as tax, legal, investment, or retirement advice or recommendations, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented, nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Broadridge Advisor Solutions. © 2019 Broadridge Investor Communication Solutions, Inc. CRN202110-255702