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.
The first cash balance plan was designed in the mid-1980s 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.
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.
HERE’S A GRAPH of the contributions possible with a cash balance / profit sharing / 401(k) combination. Deductible contributions to the cash balance plan can be much larger – and on top of – the $50,000 DC plan limit. Maximum cash balance credits reach a peak of more than $200,000 at age 62.
© 2012 Northern Consulting Actuaries, Inc. dba Van Iwaarden Associates.