What is a cash balance plan?

A cash balance plan is considered to be a defined benefit hybrid, under which a separate account is maintained for each participant. The employer credits a certain percentage of compensation to each account and credits each account with interest earned. The amounts to be contributed are actuarially determined to insure sufficient funds to provide for the benefits promised. If, at retirement, the balance in a participant's individual account is less than the amount promised by the employer, the participant will receive the promised amount. Participants may elect to receive their benefits in a lump sum or as an annuity.

Because benefits are not based solely on actual contributions and forfeitures allocated to an employee's account and the actual investment experience and expenses of the plan allocated to the account, the arrangement is treated as a defined benefit plan, rather than as a defined contribution plan. Accordingly, the plan is required to provide definitely determinable benefits, use a fixed interest rate, and adhere to the minimum funding standards.

Amounts accrued in a cash balance plan are not frozen in value when an employee changes jobs. Employees may roll over amounts in the plan of their former employer into the plan of their new employer, or into an IRA, because a hypothetical account balance is required to be maintained by the former employer.

Employers bear the risk of investment losses under a cash balance plan, unlike a defined contribution plan where employees assume investment risks. The cash balance plan, however, helps employers reduce future benefit accruals, and employer contributions to the plan may be deducted.

Plan conversions. . In 1999, the IRS instituted a moratorium on processing cash balance applications when it was discovered that conversions might present age discrimination issues. However, the IRS lifted the moratorium in December 2006. Also, the U.S. Supreme Court let stand a federal appeals court decision holding that a cash balaqnce plan did not unlawfully discriminate against its older workers.

Pension Protection Act. The Pension Protection Act of 2006 (P.L. 109-280, 120 Stat. 780, signed Aug. 17, 2006) creates rules for testing cash balance plans for age discrimination, but the rules do not apply prior to June 29, 2005. The Act clarifies that, by reflecting in the plan that older workers have less time until retirement age, cash balance plans do not violate age discrimination rules if everything else is equal.

In the case of a conversion from a defined benefit plan to a cash balance plan after June 29, 2005, each participant’s benefit after conversion must be no less than the sum of the participant’s old-formula benefit at the time of conversion plus the participant’s benefit earned for post-conversion service under the new formula.