Cash balance plans are a type of defined benefit retirement plan designed to blend features commonly found in traditional pension plans with those of defined contribution plans, such as 401(k)s. Unlike typical defined contribution plans where the employee bears the investment risk, in a cash balance plan, the employer assumes the investment risk and guarantees a predetermined benefit at retirement.
Here’s how these plans generally work: an employee is credited each year with a “pay credit”—usually a percentage of their salary—and an “interest credit” based on a fixed or variable rate that accumulates over time. These credits together create a hypothetical account balance presented to the employee. However, unlike a defined contribution plan, the actual investments are pooled and managed by the employer or plan fiduciaries, and the benefit amount is guaranteed regardless of market performance.
Cash balance plans offer several benefits. They provide employees with a clearer picture of their retirement savings through the notional account balance and deliver predictable retirement income. For employers, these plans can be more flexible than traditional defined benefit plans, and they help attract and retain key talent by offering competitive retirement benefits.
These plans are subject to regulatory rules by the IRS and the Department of Labor. Contributions are generally tax-deductible for employers, and employee benefits are typically taxed upon distribution. Participants should be aware of vesting schedules which determine when they gain full rights to the employer contributions.
According to IRS guidelines, cash balance plans must comply with specific nondiscrimination and funding requirements to ensure fairness and financial health of the plan. For example, the plans must pass the minimum funding standards to guarantee benefits can be paid as promised.
Cash balance plans often appeal to mid-sized companies and professional practices that want to provide higher retirement benefits than standard 401(k)s, especially for highly compensated employees. These plans can be designed to integrate with other retirement accounts, enhancing an employee’s overall retirement strategy.
For more detailed insights, you may explore related topics like Defined Benefit Plans which explain the traditional pension framework, and Retirement Plans for a broad understanding of retirement savings options.
External resource: Visit the IRS Cash Balance Plan FAQ for official guidelines and rules regarding these plans.
