How do cash balance plans work?
In a typical cash balance plan, a participant’s account is credited each year with a pay credit (such as 5 percent 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 one-year Treasury bill rate). Increases and decreases in the value of the plan’s investments do not directly affect the benefit amounts promised to participants. Thus, the investment risks and rewards on plan assets are borne solely by the employer.
Cash balance plans are designed to include the characteristics of both defined benefit (DB) and defined contribution (DC) plans. The DB part pays a benefit based on a predetermined formula, in this case, average pay over the employee’s tenure with your company. Also like DB plans, cash balance plans are employer funded and guaranteed by the Pension Benefit Guaranty Corporation. Employers also bear the investment risk and rewards under cash balance plans. The DC part is a recordkeeping mechanism that creates an individual account for each participant that accumulates assets over time. These are hypothetical accounts only. Cash balance plans are really DB plans and are funded on actuarial tables. In traditional DB plans, the pension benefit is computed from a formula that is based in large part on years of service and pay during the final years before retirement. Hence their popularity with “lifer” employees. Under cash balance plans, employer contributions are based on an annual benefit
DOL Response: In a typical cash balance plan, a participant’s account is credited each year with a pay credit (such as 5 percent 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 one-year Treasury bill rate). Increases and decreases in the value of the plan’s investments do not directly affect the benefit amounts promised to participants. Thus, the investment risks and rewards on plan assets are borne solely by the employer. 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 participan
