Defined Benefit Plan

Cash Balance Plan

A cash balance plan is a defined benefit plan that resembles a defined contribution plan. Under a cash balance plan, a “hypothetical” account balance is established on behalf of each employee. Each year, the hypothetical account balance is credited with a “contribution credit” and an “interest credit”. The contribution credit is a flat amount or a percentage of compensation. The interest credit is usually based on a guaranteed rate or some recognized index, like the 30 year U.S. Treasury rate. Both the contribution credit and interest credit are specified in the plan document and are guaranteed by the employer. As in a traditional defined benefit plan, the employer in a cash balance plan bears the investment risk. 

An actuary determines the annual contribution each year to fund a guaranteed benefit. When an employee becomes entitled to receive benefits, the benefits are defined in terms of an account balance. The employee can elect to receive the benefits as a lump sum payout, which is the amount in the account balance. The employee can also elect to receive the benefit in the form of a monthly payout. 

In determining the contribution credit, the maximum compensation that is taken into account is $275,000 (for 2018). Because it is a defined benefit plan, the maximum annual retirement benefit is the highest consecutive three-year average compensation or $220,000 (for 2018), whichever is less. These limits are adjusted each year to reflect changes in the cost of living index.

A cash balance plan is particularly useful for partnerships in which the plan sponsor wants to provide the same benefit amount to partners with different ages.

There are other advantages: 

· Employers can define plan benefits in terms of contribution amounts.

· Deductible contributions are higher than in defined contribution plans.

· Because benefits are defined in terms of an “account balance”, they are easily understood by employees.