A cash balance plan is an employer-funded retirement plan, which grows by the employer’s annual contributions plus interest. As with other retirement plans, the amounts in a cash balance plan grow tax deferred (that is, they are not taxed until distribution).
Retirement plans are generally classified either as defined benefit or defined contribution. A cash balance plan is, technically, a defined benefit plan, because it pays a guaranteed rate of return on contributions. However, benefits paid at retirement are not based on the employee’s years of service, as is usual for a defined benefit plan, but on total account balance, as in a defined contribution plan. For this reason, a cash balance plan is, effectively, a hybrid of a defined benefit and defined contribution plan.
When an employee changes jobs, or retires, the employee can take the cash balance as a lump sum (and pay tax) or roll the lump sum over, tax free, into an individual retirement account (IRA). Alternatively, an employee can convert the balance to an annuity that is paid monthly at retirement.
Cash balance plans are very popular, especially among small businesses, which now account for most of these plans (i.e., plans with fewer than 10 participants). For many small businesses, the owners also are employees, like law and medical practices, etc. And a cash balance plan can provide large benefits to owners-employees and smaller benefits to other employees, subject to modest nondiscrimination rules.
From 2001 to 2020, the number of cash balance plans increased 15-fold—from 1,477 to 22,657. As a percentage of all defined benefit plans, which have been dwindling in popularity among private employers, cash balance plans increased from about 3 percent in 2001 to almost 50 percent in 2020. Cash balance plan assets now exceed $1.2 trillion.
Cash balance plans allow large contributions, often hundreds of thousands of dollars a year for some participants (the maximum annual contribution depends on the age of the employee). The maximum balance for a participant in a cash balance plan is $3.4 million for 2023, which is adjusted annually for inflation.
Employers also can couple cash balance plans with defined contribution plans, like 401(k)s with profit sharing, which have a maximum contribution of $73,500 for 2023. By using both types of plans, retirement tax benefits can be compounded and increased substantially. One 2014 report found that an estimated 96 percent of cash balance plans are add-ons to defined contribution plans, most commonly to 401(k) plans.
Rollovers from cash balance plans to IRAs are a major element of mega-IRAs which, in recent years, have troubled some policymakers.
Donaldson, Grant S. 2023. “The Rise of the Cash Balance Pension Plans.” Journal of Accountancy. London, UK: Association of International Certified Professional Accountants.
Elliott, Kenneth R., and James H. Moore Jr. 2000. “Cash Balance Pension Plans: The New Wave.” Washington, DC: Bureau of Labor Statistics.
Futureplan. 2014. “2014 National Cash Balance Research Report.” Los Angeles, CA: Kravitz.
Futureplan. 2023. “2023 National Cash Balance Research Report.” Los Angeles, CA: Kravitz.
Hemel, Daniel, and Steve Rosenthal. 2011. “Mega-IRAs, Mega-401(k)s, and Other Mega-Retirement Accounts: Statement for the Record.” University of Chicago Coase-Sandor Institute for Law & Economics Research 936. http://dx.doi.org/10.2139/ssrn.3903624.
Rosenthal, Steven M. 2021. “Mega IRAs Reflect Mega Legislative Mistakes.” Washington, DC: Urban-Brookings Tax Policy Center.
US Department of Labor. 2011. “Fact Sheet: Cash Balance Pension Plans.” Washington, DC: US Department of Labor.