How do cash balance plans differ from traditional defined benefit plans?

A cash balance pension plan is a specific type of defined benefit plan structure. The plan is solely funded by the employer and the plan document defines the participant contribution formula. With a “traditional” defined benefit plan, the participant’s retirement benefit is expressed as a monthly annuity that is payable upon retirement. This can be confusing because the current value of the employee’s account or accrued benefit isn’t apparent.

The IRS technically calls a cash balance plan a defined benefit plan because there is a benefit formula clearly defined in the plan. But it is generally considered a “hybrid” between a defined benefit plan and a defined contribution plan. This is because each employee’s benefit is essentially expressed as an account balance (somewhat like a 401(k) plan).

Each cash balance plan participant will receive both an annual interest credit and a pay credit. As such, a participant’s balance will increase each year by the amount of their pay credit and their interest credit.

Both traditional defined benefit plans and cash balance plans are required to offer payment of an employee’s benefit in the form of a series of payments for life. However, traditional defined benefit plans define an employee’s benefit as a series of monthly payments for life to begin at retirement, but cash balance plans define the benefit in terms of a stated account balance. These accounts are often referred to as “hypothetical accounts” because they do not reflect actual contributions to an account or actual gains and losses allocated to the account.