Cash Balance Retirement Plans Are Becoming Popular Alternatives To Pensions
Kravitz, a national designer and administrator of corporate retirement plans, recently released their 2012 National Cash Balance Research Report, which indicates that cash balance plans continue to grow much faster than all other types of retirement plans. In 2010 (the most recent year for which IRS reporting data is available), the number of new cash balance plans increased 21% as compared to a 1% decline in new 401(k) plans. Since 2001 the number of cash balance plans has grown from 1,337 to 7,064, with 11.1 million participants currently holding $713 billion in total plan assets.
A cash benefit plan is a defined benefit plan similar to a company pension plan. Both types of plans guarantee a certain payout at retirement. However, the benefit calculation is different. With a pension, payout is based on final salary (typically 50% of the employee’s average salary over the last three years of employment). A Cash Balance Plan guarantees a target final account balance instead, based on an annual salary-based contribution credit (for example 5%) and an interest rate growth credit (such as matching the growth in the CPI or in 1-year Treasury notes). In both cases, the employer bears all the investment risk, one of the biggest advantages of defined benefit plans over defined contribution plans like 401(k)s or SEPs. With a defined contribution plan, the only company guarantee is the contribution. It’s left to the employee to invest the contributions properly.
The downside to a cash balance plan is the fact that it provides maximum benefit only to younger employees since the benefit formula is based on growth over time. Pensions benefit all workers equally since the payouts are based on final salaries largely independent of the number of years spent with the company.
Some other common advantages of cash balance plans and pensions are federal protection through the Pension Benefit Guarantee Corporation (PBGC) in case the employer goes bankrupt or mismanages the plan, and the ability to take the payout as a guaranteed annuity, including an option to pay some portion of the annuity to a surviving spouse.
The Kravitz report found that companies more than double contributions to employee retirement savings when adding cash balance plans: the average employer contribution to staff retirement accounts is 6% of pay in companies with both cash balance and 401(k) plans, compared with 2.3% of pay in firms with 401(k) alone. And the greatest growth has been at small firms with fewer than 100 employees.
The growth of cash balance plans is a welcome alternative to the accelerating disappearance of company pensions in the private sector. However, very small businesses may find the administration cost prohibitive.
Here’s a link to the Kravitz research: http://cashbalancedesign.com/articles/documents/NationalCashBalanceResearchReport2012.pdf.
For more information on cash balance plans in general, here is some Q&A from the U.S. Dept. of Labor: http://www.dol.gov/ebsa/FAQs/faq_consumer_cashbalanceplans.html.