What are “cash balance pension plans”?
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UPDATED: Jul 16, 2021
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Cash balance plans are a defined benefit plan that defines the promised benefit in terms of a stated account balance. They are designed to appeal to a mobile workforce. They are guaranteed by the federal Pension Benefit Guaranty Corp.
In a typical cash balance plan, a participant’s account is credited each year with a “pay credit” (such as 5% of compensation from his or her employer) and an “interest credit” (either a fixed rate or a variable rate that is linked to an index such as the 1-year U.S. Treasury bill rate). Increases and decreases in the value of the plan’s investments do not directly affect the benefit amounts promised to participants.
When a participant becomes entitled to receive benefits under a cash balance plan, the benefits that are received are defined in terms of an account balance. For example, assume that a participant has an account balance of $100,000 when he or she reaches age 65. If the participant decides to retire at that time, he or she would have the right to an annuity. Such an annuity might be approximately $10,000 per year for life. In many cash balance plans, however, the participant could instead choose (with consent from his or her spouse) to take a lump sum benefit equal to the $100,000 account balance.
In addition to generally permitting participants to take their benefits as lump sum benefits at retirement, cash balance plans often permit vested participants to choose (with consent from their spouses) to receive their accrued benefits in lump sums if they terminate employment prior to retirement age.
Traditional defined benefit pension plans do not offer this feature as frequently.