Benefits & ERISA Law

Cash Balance Plan Basics Explained

By Suzanne Wynn

The January 2009 edition of the Journal of Accountancy has a good general article on cash balance plans. Written by Raymond D. Berry of Grant Thorton LLP in Chicago, Plan Design in the Balance: Weighing the Pros and Cons of Cash Balance Plans provides a general explanation of what a cash balance plan is, and how cash balance plans differ from defined contribution plans. It starts:

A cash balance plan is considered a defined benefit plan and must follow the rules relating to those plans. However, a cash balance plan looks like a defined contribution plan to the participant. A hypothetical account is maintained for each participant, the company makes annual notional contributions, and interest is credited on the account. The contribution to the account is either a flat dollar amount or a percentage of compensation. The interest credited is either a fixed rate (for example, 5%) or tied to an index, such as the 30-year Treasury bond rate. Like any defined benefit plan, benefits are based on the plan?s formula and not on the actual investment earnings on plan assets. Actual investment earnings of the plan assets also do not affect the account balance. Thus, the company rather than the employee bears the investment risk. This is in contrast to a money purchase type of plan where there are actual individual accounts for which the plan sponsor must also make annual contributions. However, a money purchase plan is a defined contribution plan and the plan participant, not the plan sponsor, bears the investment risk.

The article also includes some handy charts, including one of my favorite charts which shows how the interest credit and pay credit works for a participant.

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Full post as published by Pension Protection Act Blog on January 05, 2009 (boomark / email).