A cash balance plan is a type of defined benefit retirement plan where your benefit grows like a hypothetical account with pay credits and interest credits.
A Cash Balance Plan is a unique type of employer-sponsored retirement plan that blends features of both defined benefit pensions and defined contribution plans. Although it is legally a defined benefit plan, it presents your retirement benefit as a hypothetical account balance that grows every year based on a set formula. This structure makes the plan easier for employees to understand while still providing the security of a traditional pension.
Below is a clear and simple breakdown of how cash balance plans work, why employers use them, and what they mean for your retirement future.
How a Cash Balance Plan Works
Cash balance plans promise workers a benefit that builds over time through two main components:
1. Pay Credits
These are contributions your employer adds to your hypothetical account each year.
They are usually expressed as a percentage of your salary (e.g., 5% of annual pay).
2. Interest Credits
Your account also receives an annual interest credit, often a guaranteed rate or an index-based rate (such as the 30-year Treasury rate).
Even if the market performs poorly, the interest credit is still applied — giving you predictable growth.
Although the plan looks like an account, the money is not actually in your own investment account. Instead, the employer manages the underlying investments and promises to pay you the balance when you retire or leave the company.
Why Cash Balance Plans Are Popular
Cash balance plans have become increasingly common as companies move away from traditional pensions. Here’s why:
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Easier for employees to understand than a lifetime monthly pension.
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Portable benefits — you can often take the lump sum with you when changing jobs.
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Predictable growth because interest credits are defined by law or by plan terms.
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Employer bears investment risk, not the employee.
Because they are still defined benefit plans, cash balance plans are insured by the Pension Benefit Guaranty Corporation (PBGC). This means if the employer can’t meet its obligations, PBGC may step in to cover some or all of the promised benefits, subject to limits.
Example of a Cash Balance Plan
Imagine you earn $60,000 per year. Your employer offers a cash balance plan with:
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Pay credit: 5% of salary
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Interest credit: 4% guaranteed annually
Year 1
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Pay credit: 5% × $60,000 = $3,000
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Interest credit: $0 (applied the next year)
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Account balance: $3,000
Year 2
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Pay credit: another $3,000
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Interest credit: 4% × $3,000 = $120
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Account balance: $6,120
This balance continues to accumulate every year. When you retire, you can typically choose between a lump-sum payout or a lifetime monthly annuity.
Cash Balance Plans vs. 401(k)s
Although a cash balance plan “looks” like a 401(k), it works very differently.
| Feature | Cash Balance Plan | 401(k) |
|---|---|---|
| Type | Defined benefit | Defined contribution |
| Who funds it? | Employer | Employee (sometimes employer matches) |
| Investment risk | Employer | Employee |
| Benefit shown as | Hypothetical account | Actual account balance |
| PBGC-insured | Yes | No |
This mix of simplicity and security makes cash balance plans an attractive option for many workers.
What to Consider If You’re in a Cash Balance Plan
Before planning your retirement, be sure to understand:
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How your pay and interest credits are calculated
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Whether you can take a lump-sum distribution
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The PBGC guarantee limits if your employer faces financial trouble
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How vesting works — many plans require 3 years of service for full vesting
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How the benefit interacts with a 401(k) or other retirement benefits
Understanding these details will help you maximize the value of your plan.
Final Summary
A Cash Balance Plan is a modern type of defined benefit plan that presents your pension as a growing hypothetical account. Your balance increases every year through employer-funded pay credits and guaranteed interest credits. These plans are generally PBGC-insured, offer predictable growth, and provide retirement security without requiring employees to manage investments.
If you want a retirement option that blends the clarity of an account balance with the security of a pension, a cash balance plan is one of the simplest and easiest types to understand.
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