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Defined Benefit Services

A cash balance plan is a defined benefit plan that gives the appearance of operating more like a 401(k) plan than a traditional defined benefit plan.

How it Works:

Like a 401(k) plan, each participant has an account and his or her benefit is based on the value of the account. However, unlike a 401(k) plan, this account is only hypothetical. It exists only on paper and is for recordkeeping purposes only. No assets are segregated in the account and the participant does not direct the investment of the account.

The plan’s formula provides that a hypothetical amount will be credited to the hypothetical account. There are a variety of ways the amount can be calculated. For example, the amount can be calculated as follows:

  • A fixed dollar amount (such as, $10,000 a year)
  • A percentage of compensation (such as, 5% of compensation)
  • A multiple of compensation over a set amount (such as,

10 times compensation over $90,000)
Usually, the amount is credited to the account annually at the end of the plan year.

The account is then credited with “interest” based on a rate specified in the plan. Although the interest rate can be any rate, for actuarial reasons, it is best to apply the rate used to convert benefits to single sum payments. Normally, the rate used is the 30-year Treasury Rate. The interest rate can be credited monthly or annually. Normally, however, cash balance plans credit the interest annually. The interest credited is unrelated to the actual investment returns in the plan.

The benefit a participant receives is the actuarial equivalent of the hypothetical account. Because a cash balance plan is a defined benefit plan, it is required to provide a joint and 50% survivor annuity as the normal form of benefit payment. As a matter of course, cash balance plans permit the participant to waive that form of benefit payment (with spousal consent) and elect a single sum payment. The single sum would be essentially equal to the hypothetical account balance. 

This information was developed as a general guide to educate plan sponsors, but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements and you should consult your attorney or tax advisor for guidance on your specific situation.