Cash Balance Plans
One of the most newsworthy types of retirement plans in recent years has been Cash
Balance Plans. These designs started in the mid-1980's, and reached their popularity
in the late 1990s, when many large corporations adopted them. But in the past few
years, the plans have come under increased scrutiny and re-consideration.
What is a Cash Balance Plan?
A Cash Balance Plan is a hybrid of a defined contribution plan
and a defined benefit plan. In a defined contribution plan, each
participant has a lump sum account value credited with actual investment
returns. In a defined benefit plan, the lump sum account is defined,
including the investment or interest credit, but the contributions
can vary. Instead of defining how an employee earns an annuity beginning
at age 65, Cash Balance plans define Contribution Credits and Investment
Credit rates. For example, a Cash Balance plan may credit 5% of
pay into an employer's "notional account" and add interest
based on the 30 year Treasury Securities rate. (The term notional
account is used since there is not a real account set up in an employee's
name and there may be insufficient assets in the plan to cover the
notional account balance.)
Like all "qualified" retirement plans, Cash Balance plans must meet
many legal standards, most notably those of ERISA and the Internal Revenue Code. A
September 2000 GAO study noted that these plans are most popular with larger employers;
19% of the Fortune 500 companies now offer them.
Who Benefits?
Cash balance plans often favor younger, more mobile employers over older participants
nearing retirement. In a traditional defined benefit plan, everyone in a plan earns
the same amount of annuity per year, yet the value is highest for older employees
nearing retirement. In Cash Balance Plans, there is no increased value placed for
years of service. In addition, younger workers benefit in that the plans are portable
and recognize their increasing mobility.
Plan Criticisms
Cash Balance plans have come under recent criticism, most often because employer
communications to employees have highlighted the positive aspects of the plan while
avoiding potentially negative elements. One of the principle criticisms concerns conversion
to Cash Balance from a traditional plan. High interest assumptions are often used
to create an employee's starting account balance, requiring significant understanding
on the employee's part to understand the potentially negative impact. In addition,
there have been major differences between the interest credit rates and the actual
investment earnings, resulting in increased employer risk during a down market. Some
mid-career employees have found that after the conversion, their benefits would be
30% less than had the previous, traditional formula been left in place.
Our View
A Cash Balance plan design is one of the many tools that a plan sponsor can use
to provide valuable benefits to its participants. Like all plans, the details and
the implications - for both the plan sponsor and the participants - must be fully
explored and understood.
In our work with Cash Balance plans, we pay particular attention
to conversion issues, specific plan design, and participant communication.
We look at the long-term effects of changing plans, as well as the
legal impact. While some companies may be prepared to take the additional
risk of adopting this relatively new plan design, it may not be
right for every corporation.
Bolton Partners Experience
Bolton Partners has unique experience working with Cash Balance Plans since
1988. In 1999, the firm was hired by the Society of Actuaries to prepare the industry's
Cash Balance study on design and funding issues. This study can be found on the Society's
web site at www.soa.org.
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