Cash balance plans are a type of defined benefit retirement plan that combines features of both traditional defined benefit plans and defined contribution plans. In these plans, employers credit a participant's account with a set percentage of their salary plus interest, providing employees with a clear statement of their retirement benefits. This structure makes cash balance plans appealing for employers and employees alike, as they offer predictable benefits while allowing for easier management and understanding of retirement savings.
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Cash balance plans are considered a hybrid between defined benefit and defined contribution plans, offering a fixed account balance that grows over time.
These plans are attractive to younger employees because they provide immediate vesting and portability when changing jobs.
Employers have the ability to control costs more effectively with cash balance plans compared to traditional defined benefit plans, as they can determine annual contribution levels.
Interest credits in cash balance plans can be set at a fixed rate or tied to an external index, such as the 30-year Treasury bond rate.
If an employer terminates a cash balance plan, participants may receive their benefits as a lump-sum payment or through annuity options.
Review Questions
How do cash balance plans differ from traditional defined benefit and defined contribution plans?
Cash balance plans differ from traditional defined benefit plans in that they provide participants with an account balance that grows with contributions and interest credits rather than a guaranteed monthly pension at retirement. Unlike defined contribution plans, which depend on investment performance, cash balance plans ensure a predictable benefit amount. This hybrid nature allows employers to manage costs while providing employees with a clearer understanding of their retirement savings.
Evaluate the advantages and disadvantages of cash balance plans for both employers and employees.
For employers, cash balance plans offer predictable costs and greater flexibility in managing retirement benefits compared to traditional pension plans. Employees benefit from immediate vesting and clear account statements, making it easier to track retirement savings. However, one disadvantage for employers may include the complexity of administration compared to simpler defined contribution plans, while employees might face lower potential returns compared to higher-risk investment options available in traditional 401(k) plans.
Assess how changes in regulations affecting cash balance plans can impact employee retirement security and employer obligations.
Changes in regulations governing cash balance plans can significantly influence employee retirement security by altering the way benefits are calculated or funded. For instance, stricter funding requirements might compel employers to allocate more resources toward their cash balance plans, ensuring that employee benefits remain secure even during economic downturns. On the flip side, if regulations become too burdensome, employers might be incentivized to reduce or eliminate these plans altogether, ultimately jeopardizing employees' long-term financial security and forcing them to rely on less predictable savings methods.
Related terms
defined benefit plan: A retirement plan where an employer guarantees a specified monthly benefit at retirement, which is calculated based on factors like salary history and years of service.
defined contribution plan: A retirement plan where both employees and employers can make contributions, and the final benefits depend on the investment performance of those contributions.
pension benefit guaranty corporation (PBGC): A U.S. government agency that protects the retirement incomes of American workers in private-sector defined benefit pension plans by insuring the payment of pension benefits.