Cash balance pension plan.
A cash balance plan is a defined benefit plan that calculates benefits in a manner similar to defined contribution plans. Each employee has a hypothetical account or "cash balance" to which contributions and interest payments are credited. Under the typical plan a fixed percentage of each employee's salary is contributed each year, and both the level of contribution and a minimum rate of return are guaranteed by the employer (i.e., the employer bears the investment risk). Contributions may be weighted for age or years of service. Unlike a true defined contribution plan, individual accounts are not maintained and participants may not direct the investments in their accounts. As with the defined benefit pension plan the plan benefits are guaranteed up to specific limits by the Pension Benefit Guaranty Corporation (PBGC). See page 487.
Compared with traditional defined benefit plans cash balance plans generally provide greater benefits to younger employees and those with shorter service (but at a higher cost), and lower benefits to older, longer service employees (at lower cost).
In an effort to reduce the costs of employee retirement plans, and offer more attractive plans to younger workers with few years of service, employers can convert their traditional defined benefit plans into cash balance plans. This conversion benefits younger workers, who not only can accrue benefits more rapidly, but will also enjoy the added advantages of portability (i.e., if the employee leaves prior to normal retirement age vested account values can be taken in a lump sum, rolled over into an IRA, or otherwise invested). However, these conversions are generally detrimental to older employees, since they occur just as these workers are reaching the age where the defined benefit formulas began to sharply raise the value of their future pension payouts. The effect is that some cash balance conversions have arguably lowered the rate of future benefit accruals. In response to this concern, the Pension Protection Act of 2006 required that future conversions of defined benefit plans to cash balance plans preclude the possibility of "wear-away" (i.e., a time after conversion during which additional benefits do not accrue).
Controversy over cash balance conversions has resulted in many employers giving employees the option of staying with the old defined benefit plan, or providing other incentives in order to mitigate loss of anticipated benefits.
See also, the discussion of qualified retirement plans on page 508.