What is a cash balance plan?

A cash balance plan is a defined benefit pension plan that states each person’s benefit as an account balance instead of a monthly payment. Each year the plan adds a pay credit and an interest credit to that account. The employer, not the employee, bears the investment risk, and federal pension law on funding and vesting applies.

The tax code’s name for the plan is an applicable defined benefit plan: a defined benefit plan whose benefit is calculated as the balance of a hypothetical account kept for each participant. The account is a record of what the plan owes, not a pot of money with the person’s name on it.

Each year the plan credits each person’s account with a pay credit, often a percentage of pay that the plan document sets, and an interest credit at a rate the plan document states. The business pays into one pooled trust, and an enrolled actuary sets the yearly contribution that keeps the trust able to pay every account.

The account balances are bookkeeping entries. The money sits in one trust for everyone in the plan, invested by the trustee. When a person leaves or retires, the vested balance is paid in the forms the plan document allows, such as a lump sum or a monthly annuity.

A cash balance plan is a defined benefit plan, even though its statement looks like a 401(k) balance. The tax code calls it an applicable defined benefit plan and gives it its own vesting and interest credit rules in section 411. The plan is a pension, and the employer bears the investment risk.

In a 401(k), which is a defined contribution plan, a person gets what went into the account plus what it earned. In a cash balance plan with a fixed or bond based interest credit, a person gets the account the plan’s formula promises, whatever the trust’s investments did. The IRS puts it plainly on its page for the plan type: benefits are not dependent on asset returns.

Defined benefit plan or 401(k)?

A cash balance plan credits each account with an interest rate written into the plan document. Federal law caps that rate at a market rate of return; a fixed rate of up to 6 percent is within the safe harbor. The interest credit is a promise to participants, not a prediction of what the plan’s investments will earn.

Earnings above the credit reduce future contributions; earnings below it raise them. Neither changes what the accounts show.

A market-based cash balance plan sets its interest credit equal to the actual return on the plan’s own investments, gains and losses alike, instead of a fixed rate or a bond yield. Treasury regulations allow that rate if the plan’s assets are diversified to minimize the volatility of returns.

A loss can lower the accounts in a bad year. The tax code still says a credit below zero may never leave an account below the total contributions credited to it. Hybrid plan is the regulations’ name for cash balance plans and similar designs.

Both are defined benefit plans funded by the employer. A traditional plan states the benefit as a monthly payment at retirement, figured from pay and years of service. A cash balance plan states the same kind of promise as an account balance built from pay credits and interest credits.

A top-heavy plan, one where key employees hold more than 60 percent of the value of the benefits, must vest on a 3-year cliff or a schedule that reaches full vesting at 6 years.

Cash balance or traditional pension?

The rules sit in several places. The tax code defines the plan in section 411, sets the funding rules in section 430 and the deduction rules in section 404, and a Treasury regulation sets the interest credit rules. Each plan’s numbers also come from an enrolled actuary’s calculation for one business, so no published table fits every owner.

Cash balance plans are also a small share of all plans. The Department of Labor counted 26,764 cash balance plans among 836,843 private pension plans in its 2023 Form 5500 data, which leaves out one-participant plans. Each page on definedbenefits.com answers one question and quotes the law behind the answer.

No. A cash management account is a cash product that a brokerage firm offers. A cash balance plan is an employer pension plan governed by the tax code and ERISA, and its balance is a bookkeeping entry backed by one trust that holds the money for everyone in the plan. The two share a word and nothing else.

Yes. The Department of Labor counted 26,764 cash balance plans in its 2023 Form 5500 data, which leaves out one-participant plans. FuturePlan, a retirement plan administrator, counts 25,754 cash balance plans for 2023 in its 2025 Cash Balance Outlook and Trends Report, and says they are over 55 percent of all defined benefit plans.

The two counts come from different databases, so each carries its publisher. The same FuturePlan report says: “Over 95% of cash balance plans are implemented by firms with fewer than 100 employees.”

The IRS lists the defined benefit plan, which includes the cash balance plan, as the most costly and the most administratively complex type of plan. The contribution is mandatory each year within the actuary’s range, and an unpaid minimum is taxed at 10 percent, then 100 percent if it stays unpaid.

The employer bears the investment risk: benefits do not depend on asset returns, so a shortfall raises future contributions. The money is locked until age 59½, separation or plan termination, with a 10 percent additional tax on early distributions. Staff must be covered and credited under federal tests. Fees for the actuary, the administrator and the filings are paid every year.

What are the risks?