What is a Cash Balance Plan?
Dale R. Vlasek
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A cash balance retirement plan is a defined benefit plan that gives the appearance of operating more like a 401(k) plan than a traditional defined benefit plan.
How a Cash Balance Plan Works
The plan’s formula provides that a hypothetical amount will be credited to the hypothetical account. There are a variety of ways the amount can be calculated. For example, the amount can be calculated as follows:
Usually, the amount is credited to the account annually at the end of the cash balance plan year.
The account is then credited with “interest” based on a rate specified in the plan. Although the interest rate can be any rate, for actuarial reasons, it is best to apply the rate used to convert benefits to single sum payments. Normally, the rate used is the 30-year Treasury Rate. This rate is about 5%. The interest rate can be credited monthly or annually. Normally, however, cash balance plans credit the interest annually. The interest credited is unrelated to the actual investment returns in the plan.
The benefit a participant receives is the actuarial equivalent of the hypothetical cash balance plan account. Because a cash balance plan is a defined benefit plan, it is required to provide a joint and 50% survivor annuity as the normal form of benefit payment. As a matter of course, cash balance plans permit the participant to waive that form of benefit payment (with spousal consent) and elect a single sum payment. The single sum would be essentially equal to the hypothetical account balance.
Actual Deductible Contributions
Cash Balance Example
In this example, the cash balance plan credits his or her account with an amount equal to 20% of compensation and uses a 5% interest credit. In the 10 years until age 65, his or her account might look as follows:
The Chief Advantage of Cash Balance Retirement Plans
Thus, the chief advantage of a cash balance retirement plan is that it is structured like a 401(k) account plan, but permits significantly larger contributions and consequently, significantly larger benefit payments.
Cash Balance Plan Video Series
Trinity Pension Consultants has created a series of videos to help explain complicated cash balance plans. The first video is an introduction to cash balance plans, and the remaining five videos answer a specific question regarding cash balance plans.
©McDonald Hopkins LLC (2008) Dale Vlasek