Cash Balance Plan

In Detail

A cash balance plan is technically a defined benefit plan under ERISA, but it looks and feels more like a defined contribution plan to participants. Each participant has a hypothetical account that receives two types of credits: a pay credit (typically 4-8% of annual salary) and an interest credit (a guaranteed rate, often tied to Treasury rates or a fixed percentage). The account balance grows predictably each year, and at retirement or departure, the participant can take the balance as a lump sum or convert it to a monthly pension. Cash balance plans became controversial in the late 1990s when many large employers converted their traditional pension plans to cash balance designs.

Older workers argued that the conversion reduced their benefits — a phenomenon known as "wear-away" — because the cash balance formula often produced lower benefits for long-tenured employees near retirement compared to the old formula. Legal challenges and regulatory uncertainty followed, eventually resolved by the Pension Protection Act of 2006, which explicitly authorized cash balance plans and set rules for fair conversions. Today, cash balance plans are the fastest-growing type of defined benefit plan, particularly popular among professional firms, hospitals, and mid-size companies because they combine ERISA protections with predictable employer costs.