Information Center

Cash Balance Plans

A cash balance plan is a pension plan that has certain features of a 401(k) plan. A number of companies have converted their traditional pension plans into cash balance plans. This fact sheet describes cash balance plans and outlines the differences between a cash balance plan and a traditional  pension plan, and between a cash balance plan and a 401(k) plan. 

How does a cash balance plan work?

Cash balance plans give each participant a hypothetical account under the plan. These accounts are hypothetical because (1) they do not reflect money actually held for the participant under the plan and (2) there are no actual contributions made to the plan or actual earnings that are specifically for the participant’s account. Participant accounts in cash balance plans are credited annually with a “pay credit” (such as 5 percent of compensation) and an “interest credit” (such as the rate of interest based on the U.S. Treasury bill index or corporate bond index). Increases and decreases in the value of the plan’s investments do not affect benefit amounts, unless the plan has chosen to use the rate of return on plan assets as its interest rate index (which is rare).

How do cash balance plans differ from traditional pension plans?

• Statement of benefits – Traditional pension plans present the basic benefit earned under the plan as a series of monthly payments for life (an annuity) payable in the future at normal retirement age, while cash balance plans present the benefit as the worker’s hypothetical account balance. 
• Form of benefit – In a traditional pension benefits are usually paid out as an annuity, although some plans also allow a benefit to be taken as a lump sum. In contrast, cash balance plans usually offer a lump-sum payout option in addition to an annuity (monthly payments for life) as a benefit.

For example, a participant retiring at age 65 with a hypothetical account balance of $100,000 in a cash balance plan would have the right to receive a monthly pension, based on that account balance ($708 per month for life, for example). Alternatively, the participant could choose (with consent from his or her spouse) to take a lump-sum payout equal to the account balance — $100,000. 

How do cash balance plans differ from 401(k) plans?

• Participation – In cash balance plans, workers typically do not contribute to the plan; the employer contributes money on behalf of the employee. In 401(k) plans, participants generally have to contribute to the plan. In 401(k) plans, the employer can also make a matching contribution but is not required to. 
• Investment risks – As in traditional pension plans, contributions are made to a cash balance plan by the employer, plan investments are managed by a plan fiduciary, and the participant cannot select the index for interest credits. In 401(k) plans, the participant is often responsible for selecting funds in which his or her account balance is invested. 
• Lifetime annuities – Unlike 401(k) plans, cash balance and traditional  pension plans are required to offer employees the ability to receive their benefits in the form of monthly payments for life, including forms of payment that provide a survivor annuity for the spouse of the participant.
• Spousal protection – A married worker in a cash balance plan must get his or her spouse’s consent in order to take the benefit as a lump sum when the worker leaves the employer or retires. In 401(k) plans, no such consent is required if a married worker decides to cash out a 401(k). 
• Federal guarantee – Like a traditional pension plan, the benefit promised by a cash balance plan is guaranteed by the Pension Benefit Guaranty Corporation (PBGC), the federal agency responsible for insuring most private pension plans. If a traditional pension plan or a cash balance plan is terminated without having enough assets to pay all promised benefits (or, for a cash balance plan, the assets are less than the total amount of the hypothetical account balances), the PBGC has authority to assume trusteeship of the plan and to pay pension benefits up to the limits set by law. 401(k)s are not insured by the PBGC.

Can employers change your current plan to a cash balance plan?

An employer can convert a traditional pension plan into a cash balance plan by adopting an amendment to replace the traditional formula with a cash balance formula. If that happens, participants are entitled to the benefit they have earned to date under the traditional formula, but they typically cease earning any more benefits under that formula. Instead, they start earning benefits under the new cash balance formula after the conversion. Upon retirement, a vested participant receives whatever he or she has earned under the pre-conversion traditional formula, plus whatever he or she has earned under the post-conversion cash balance formula.