Cash Balance Plans Explained

What to know about the DB plan with DC plan features.

Cash balance plans are defined benefit (DB) plans, but they have several features of defined contribution (DC) plans, explains Dave Suchsland, a senior consultant at Willis Towers Watson. Thus, they are often called “hybrid” plans.

“With a [DC plan], the money goes into your account every paycheck, earns investment income and has a balance at every quarter and every year,” he explains. “With a cash balance plan, it’s exactly the same. You have a contribution that goes into your account from your employer, it earns interest, and it grows as a lump-sum value the longer it’s in the plan.”

But cash balance plans also have differences from both DB and DC plans. Unlike a DC plan, where investors can lose retirement assets based on market fluctuations, the investment risk of a cash balance plan is managed by an employer or investment manager, according to a fact sheet from the Department of Labor (DOL). Additionally, cash balance plans do not mandate employee contributions like in a 401(k); they are insured by the Pension Benefit Guaranty Corporation (PBGC); and they are required to offer lifetime annuities, according to the DOL. 

A cash balance plan also grows in a hypothetical account, explains Rachel Barnes, a member of the American Academy of Actuaries’ Pension Committee. This account does not reflect actual contributions, gains or losses related to the cash balance plan, whereas an account with a DC plan does.

“It’s not like there’s a little pool of cash that’s associated with that particular participant with a cash balance,” Barnes explains. “The returns on that account are what’s called an interest credit, and that’s not necessarily the plan’s investment returns. It can be a fixed amount, fixed interest or tied to some market rate like a Treasury bond rate.”

Cash balance plans use an interest crediting rate (ICR) to apply a return on participant balances, Suchsland says.

“There’s the contribution, or pay credit, and then an interest rate,” Suchsland says. “The contribution or pay credit would be written into the plan, at, for example, 4% of pay. It would then grow by 4% in every quarter. The plan would have a defined interest rate basis, and that may be tied to 30-year Treasury bonds, 10-year Treasury bonds—all different ways that you can define the interest crediting rate.”

Barnes notes that most cash balance plans will offer a fixed interest rate at no greater than 5% or 6%, or whatever the current market rate is. Whatever is accrued will then go into a participant’s hypothetical account, she adds.

Also, while DC plans allow participant loans and hardship or in-service withdrawals, Barnes and Suchsland note that cash balance plans do not offer those features. “It’s not typically common or allowed because it’s not the same case as a DC plan where participants have their own money set aside,” Barnes explains.

Once participants in a cash balance plan reach retirement, the plan’s terms dictate whether they are paid in monthly installments or lump sums, according to Suchsland. However, participants cannot be paid in a combination of both. “Part of being a DB plan means you have to offer a life annuity, but almost every cash balance plan has a lump-sum option also,” he says. “It depends on the plan sponsor and any other payment options it wants to offer.”