What Is a Cash Balance Retirement Plan?

A cash balance retirement plan blends elements of traditional pension plans and modern 401(k)s. It functions as a defined benefit plan but presents benefits to employees as a hypothetical account balance. This hybrid structure is increasingly popular, offering predictable retirement benefits and significant tax advantages.

Understanding the Basics of a Cash Balance Plan

A cash balance plan operates as a defined benefit pension plan, which means the employer promises a specific future benefit to employees. Unlike traditional pensions that often define benefits as a monthly payment based on salary and years of service, a cash balance plan expresses an employee’s benefit as a hypothetical account balance. This individual account is a record-keeping entry, not an actual investment account owned by the employee. The employer, not the employee, manages the actual investments of the plan’s assets.

Each year, an employee’s hypothetical account is credited with two main components: “pay credits” and “interest credits.” Pay credits are typically a percentage of the employee’s salary, such as 5% to 8% of compensation, or a flat dollar amount. Interest credits represent a guaranteed rate of return applied to the account balance. This interest rate can be fixed or tied to an external index, such as the one-year Treasury bill rate, commonly ranging from 4% to 5%.

The employer assumes all investment risk associated with the plan’s assets. This means the employer must ensure sufficient funds to cover promised pay and interest credits, regardless of investment performance. If investments perform poorly, the employer must contribute more to meet guaranteed benefits. Conversely, if investments perform well, the surplus can reduce future employer contributions. This structure provides employees with predictable growth in their retirement savings, shielding them from market fluctuations.

Key Features and Characteristics

The employer holds primary responsibility for funding and managing the plan’s investments. This means the employer bears the investment risk, guaranteeing the interest credit to participants regardless of actual investment returns.

Tax advantages are available for both employers and employees. Employer contributions to a cash balance plan are tax-deductible business expenses, allowing businesses to reduce their current taxable income. For employees, the growth of their hypothetical account balance is tax-deferred, meaning taxes are not paid until funds are withdrawn in retirement.

As defined benefit plans, cash balance plans fall under the regulatory framework of the Employee Retirement Income Security Act (ERISA). ERISA establishes standards for fiduciary responsibility, participation, vesting, and funding, ensuring participant protections. Many cash balance plans are also insured by the Pension Benefit Guaranty Corporation (PBGC), a federal agency that provides a safety net for pension benefits up to certain limits if a plan terminates with insufficient funds. For 2025, the PBGC maximum monthly guarantee for a single-employer plan at age 65 is $7,357.50, though professional service businesses with fewer than 26 active participants may be exempt from PBGC premiums.

Benefits in a cash balance plan are generally portable. Upon leaving an employer, participants typically have the option to receive their accumulated hypothetical account balance as a lump sum or convert it into an annuity. The lump sum can often be rolled over into an Individual Retirement Account (IRA) or another employer’s plan, preserving its tax-deferred status. Contribution limits for cash balance plans are generally higher than for defined contribution plans like 401(k)s. These limits are determined by actuarial calculations to ensure the plan can fund the promised benefits, with annual contributions potentially ranging from $100,000 to $400,000 for some individuals, depending on age and plan design, and a lifetime cap of $3.5 million for 2025.

Comparing Cash Balance Plans to Other Retirement Options

A key distinction between cash balance plans, 401(k)s, and traditional pensions lies in contribution responsibility. In a 401(k) plan, employees primarily make contributions, often supplemented by an employer match. With cash balance plans, the employer is solely responsible for contributions that fund promised benefits. Traditional pensions are also fully employer-funded, with benefits typically based on a formula involving salary and tenure.

Investment risk also differs. In a 401(k), employees bear the investment risk, as their savings fluctuate with market performance. In cash balance plans and traditional pensions, the employer assumes this risk, guaranteeing the benefit and shielding employees from market downturns.

Portability of benefits also varies. 401(k)s are highly portable, allowing employees to take their account balances with them when changing jobs. Cash balance plans offer portability through lump-sum distributions or annuity options upon separation, which can be rolled over. Traditional pensions, however, typically offer benefits primarily as monthly annuity payments for life, with lump-sum options being less common.

Contribution limits also present a notable contrast. For 2025, the elective deferral limit for a 401(k) plan is $23,500, with an additional catch-up contribution for those aged 50 and over. Cash balance plans, as defined benefit plans, allow for significantly higher contributions, sometimes reaching hundreds of thousands of dollars annually, depending on age and plan design. This higher limit makes cash balance plans particularly attractive for maximizing tax-deferred savings. Employers might choose a 401(k) for its flexibility and lower administrative burden, while a cash balance plan is often selected for its ability to provide substantial tax deductions and accelerate retirement savings for certain employees.

Who Benefits from a Cash Balance Plan?

Cash balance plans are advantageous for specific types of employers and employees. Profitable small to medium-sized businesses, including professional service firms like law firms, medical practices, and consulting firms, often find these plans appealing. These businesses can maximize tax-deductible retirement savings beyond the limits of more common plans like 401(k)s.

For employees, cash balance plans are especially attractive to older, highly compensated individuals. This includes business owners, partners, and key executives. These individuals can significantly accelerate their retirement savings in a tax-efficient manner, potentially contributing hundreds of thousands of dollars annually. The plan allows owner-employees to save a substantial amount for their own retirement while also providing a valuable benefit for other employees, which can aid in employee retention.

The structure of a cash balance plan can help business owners reduce their personal and corporate tax liabilities. Contributions are tax-deductible to the business, which can lead to considerable tax savings. While providing benefits to all eligible employees, the design flexibility of these plans often allows for higher contributions for owners and highly compensated staff, making them a strategic component of a comprehensive financial plan for successful businesses.