What is a Cash-Balance Plan?

Cash-balance plans are one form of a defined benefit plan, such as a retirement plan. Different from a defined contribution plan, the cash-balance plan operates under the principle of earning a variable rate of return on the contributions made to the plan. Unlike plans with a fixed rate, the cash-balance plan may earn lower or higher returns from one year to the next.

Increasingly over the latter part of the 20th century, the cash-balance plan began to replace more traditional retirement plans. Generally, it was possible to convert from another type of plan to the cash-balance plan without necessarily having to declare a plan termination. Since the process of making an annual contribution would continue, many workers took the changes in stride, and did not see any real reason to object to the transition.

However, there have been some questions as to how effective the cash-balance plan is in the long term. Depending on the exact structure of the plan, there is some evidence that long time employees nearing retirement age will realize a smaller retirement benefit in comparison to persons who have a defined contribution plan. While both approaches are considered defined benefit plans, there is some thought that the cash-balance plan does not reward employees who remain with a company for a long period. Especially when the employee chooses to remain all the way to retirement, the balance of the plan appears to amount to less of a benefit.

At present, the number of conversions to a cash-balance plan has slowed considerably. Investigation into the feasibility of the cash-balance plan, including some projected models and the current functioning examples, is underway by a number of worker advocate organizations. In some instances, there is support for redefining the cash-balance plan as something other than an alternate defined benefit plan, so that the differences between a cash-balance plan and a defined contribution plan are more easily understood.