3720 / What is a cash balance plan?
A cash balance plan is a defined benefit plan that calculates benefits and contributions in a manner similar to the way that defined contribution plans make those calculations. The similarity ends in that a cash balance plan’s calculations require an actuary. A cash balance plan resembles a defined contribution plan in that each employee has a hypothetical account, or “cash balance,” to which contributions and interest payments are credited. In a typical cash balance plan, the employee’s benefit accrues evenly over the years of service, with annual pay credits to the hypothetical account. There is no separate account. These pay credits usually are a fixed percentage of pay that is stated in the plan document, such as 4 percent.
With no separate account, there is no directed investing available. As with other defined benefit plans, the employer bears both the risk and the benefits of investment performance. That is, losses in the plan’s investments generally require additional employer funding. The actual amount that must be contributed is determined actuarially. This ensures that the plan has sufficient funds to provide the promised benefits.
For plan years beginning in 2012, the interest credit (or the equivalent amount) for any plan year must be at a rate that is not greater than a “market rate” of return. The term “market rate” of return is defined in regulations issued in 2010.1 A plan will not fail this requirement merely because it provides for a reasonable minimum guaranteed rate of return or for a rate of return equal to the greater of a fixed or variable rate.2 An interest credit of less than zero may not result in the account balance being less than the aggregate amount of contributions credited to the account.3 This legislative change eliminates the possibility of “whipsaw,” in which disparate interest rates used for crediting and discounting purposes resulted in the discounted present value of employees’ accounts being higher than the theoretical account’s value.