Cash Balance Plans
Contrary to popular belief, Cash Balance plans are Defined Benefit plans since they promise a benefit to plan participants. The benefit formula is expressed as a hypothetical credit that receives an earnings credit each year. While the look is very much like a defined contribution plan, the plan sponsor is required to fund at least minimum required contributions each year and the plan sponsor bears the investment risk.
Cash Balance plans are uniquely qualified to meet the varying needs of multiple owners for professional firms and entrepreneurial companies. It is easier to track the benefit owed to each plan participant and the underlying assets backing up that benefit. Traditional Defined Benefit plans normally base their formulas on some form of final average compensation. This can cause plan contributions to escalate over time as a participant’s compensation increases. On the other hand, Cash Balance plan formulas make it easier to manage the plan sponsor’s cost since the hypothetical credits are expressed as either a percentage of the current year’s compensation or a flat dollar amount.
The Pension Protection Act of 2006 (PPA) resolved some underlying concerns with respect to these plans and, as such, they have become very popular in helping the baby boomer generation accumulate retirement benefits very fast.
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