What are cash balance plans?
Cash balance plans are defined benefit (DB) plans that have the look and feel of defined contribution (DC) plans.
- Defined benefit is a descriptive term: the benefit is what’s defined in the plan. In traditional defined benefit plans, the benefit is a monthly retirement payment. In cash balance plans, the benefit is an account balance.
- Defined contribution is also a descriptive term: the contribution is what’s defined in the plan. Common forms of these are 401(k) and profit sharing plans.
The first cash balance plan was designed in the mid-1980’ s for Bank of America. It was to enhance employee appreciation of the pension plan: employees understood an account balance better than they understood a future monthly benefit.
Cash balance plans are still used for ease of understanding, but most new plans are set up to increase business owners’ retirement savings. Maximum annual tax deductions can be much higher for defined benefit plans (often $100,000 or more) than for defined contribution plans (about $50,000). Since 2000, owners can have both deductions, e.g. $100,000 cash balance plus $50,000 401(k)/profit sharing.
Cash balance plans work better than traditional pension plans for multiple-owner firms like law firms and medical groups. In a traditional plan, one partner can end up paying for another’s benefit. That doesn’t happen in a properly designed cash balance plan: what comes out of your taxable pay goes straight into your own cash balance account.
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