What is a cash balance plan

A cash balance plan is a defined benefit plan, but exhibits features of both defined benefit and defined contribution plans. The most recognizable feature of the cash balance plan is its use of a separate account for each participant.

If the plan replaces a defined benefit plan, participants are credited with an opening balance -- typically the actuarial present value of their accrued prior plan benefits. Thereafter, the employee's cash balance account receives additional credits. These are likely to be computed as a flat rate percentage of the employee's pay, such as 4 percent or 5 percent. In addition, employees' balances grow based on interest credits. The rate varies from year to year and is communicated to employees before the start of the year. As an example, it might be the yield on one-year Treasury bills. The interest rate is not tied to the actual investment performance of the plan's assets and is determined independently, based on specific provisions in the plan document. The plan may express a minimum or maximum rate; the maximum cannot be less than the highest standard interest rate. The amounts an employer contributes to the plan are determined actuarially to ensure sufficient funds to provide for the benefits promised by the plan.

Cash balance plans provide the higher benefits for younger employees and lower benefits for older employees, in contrast to traditional defined benefit plans. However, the cost of providing these benefits is also correspondingly higher for younger employees and lower for older employees, as compared with a traditional defined benefit plan.