What Is a Cash Balance Plan? 

A cash balance plan is an employer-sponsored retirement account that combines defined benefits and defined contributions.

It provides defined benefits through the employer’s contributions to the employee’s account, just like a traditional pension plan does. However, it also has a yearly contribution amount that follows some type of interest rate, thus providing more flexible withdrawals compared with pension funds.  

It’s an account that’s similar to a traditional pension plan, but where the employee has more control over the investments.

Many employers switch to cash balance plans in order to attract new employees and allow them to save more towards retirement than they would under a 401(k) or other defined contribution plan.

How Does It Work?

In a cash balance plan, the contributions from employers are fixed on a yearly basis. These fixed contributions don’t change over time even if the employer’s own financial situation changes.

Each employee has his or her own account, and all employees earn interest based on the same interest rate established for the cash balance plan. The rate of return is fixed, and the employee can’t make any changes to it.

The value of each individual account is based on how much money an employer puts in and the interest earned on that money. When a person retires or leaves his job there’s a lump-sum distribution from their balance. This distribution is taxable and must be spread out over five years.

The combined employer and employee contribution to the cash balance plan is taxed annually. The interest earned on this money isn’t taxed until withdrawal. At the time of retirement, participants receive a lump-sum distribution, which is taxable income in that year.

Who Should Consider This Type of Plan?

It’s an attractive option for employers who want to provide more retirement benefits to employees, especially those whose business is growing or who are looking to switch from a defined contribution plan.

A cash balance pension plan may be an alternative for people who are close to retirement age and are looking for a way to build up their savings without too much risk of losing it all if the market crashes.

The cash balance plan offers a bit more flexibility in terms of making withdrawals. While many defined benefit plans have restrictions about how much can be withdrawn each month, pensions are required to begin payments at age 62 even if the retiree wants to wait until later.  

The Advantages and Disadvantages of the Cash Balance Plan

Advantages:

  • Contributions from employees and employers are made in a way that provides a stronger retirement package.
  • It’s easier to understand how the plan works compared with a 401(k) or other defined contribution plan.
  • There’s no limit when it comes to making contributions, whereas some plans have annual caps.

Disadvantages:

  • There are limitations on when you can take withdrawals.
  • The combined yearly contributions, plus interest earned, is taxable income at the time of withdrawal.

Cash Balance and Traditional Pension Plans Compared

Cash balance plans and traditional pensions both provide defined benefits, but in different ways. With a cash balance plan, the yearly contributions from employers are fixed, whereas with a pension the amount is based on how much someone earned during his or her career.

A person can’t control what kind of return is earned when they invest in a cash balance plan, but in a traditional pension, the amount of yearly contributions can vary with each raise.

Cash balance plans are more flexible when it comes to withdrawing money since there aren’t restrictions on when someone retires, whereas pensions entail fixed annual payments that must begin when an individual is 62 years old.

Cash Balance and 401(k) Plan Compared

A 401(k) plan is similar to a cash balance retirement account, but there are some differences. With a 401(k), the employer makes contributions to an employee’s individual account, whereas in a cash balance plan it’s up to each worker to decide how much money goes into his or her account.

The returns earned on money put into 401(k) plans are based on investments made by the worker, whereas with a cash balance plan the return is fixed.

A 401(k) doesn’t have to begin distributions at age 62; someone can wait until he or she retires to take money out of the account, whereas pensions entail fixed annual payments that must begin when an individual is 62 years old.

The Bottom Line

While the cash balance plan is a great way for employers looking to provide more benefits and flexibility to workers, it’s not right for everyone. The plan may be better suited for those who expect to remain with their current employer until retirement.

The combined yearly contributions, plus interest earned, from a cash balance pension plan is taxable as income at the time of the withdrawal.

It’s a good option for people who want to make contributions in a way that will improve their retirement benefits, but it isn’t right if you prefer more flexibility in your investments and greater control over when you can withdraw money.

The cash balance plan is an employer-sponsored defined contribution retirement plan that combines features of traditional pensions and 401(k) plans. Cash balance plans are sometimes referred to as money purchase pension plans, but they're not the same thing. With a money purchase pension plan, employers make contributions based on how much an employee earns during his or her career.
The cash balance plan provides specific benefits based on the employer's contributions. It's similar to a 401(k), but there are some differences. Cash balance plans guarantee employees will receive at least what they put in over time, unlike with traditional pensions where the amount of annual payments can change depending on how much an employee earned during his or her career. Cash balance plans are also more flexible since there are no age restrictions to when someone can withdraw money, whereas pensions entail fixed annual payments that must begin when an individual is 62 years old.
Anyone who wants to take advantage of a retirement savings program should consider the cash balance plan. It's a great plan for employers who want to offer more benefits and flexibility to employees, while capping their yearly contribution amounts. Cash balance plans are also beneficial because they provide guaranteed returns based on what an employee puts in, whereas with 401(k)s the return is variable.
Some of the advantages of the cash balance plan include: - Cash balance plans are more flexible since there aren't restrictions on when someone retires. Cash balance pension funds can be accessed at any time , whereas with 401(k)s there are penalties for early withdrawals - Cash balance plans provide guaranteed returns, unlike 401(k)s where the amount of annual payments can vary depending on how much an employee earned during his or her career - Cash balance plans don't have age restrictions like traditional pensions, which require fixed annual payments that must begin when an individual is 62 years old
Some of the disadvantages of the cash balance plan include: - Cash balance plans entail fixed returns, whereas 401(k)s offer variable returns based on market performance (they can rise or fall) - Cash balance plans limit how much an employee can contribute to a retirement account each year, unlike with 401(k)s where the amount is unlimited - Cash balance plans are employer funded, whereas 401(k)s can be employee funded
True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.