Who Makes Payments Into a Cash Balance Plan?

A cash balance plan is a specific type of defined benefit pension plan that presents an employee’s retirement benefit in terms of a hypothetical account balance, resembling a defined contribution plan. This structure allows participants to see their accumulated benefit as a growing sum, credited annually with “pay credits” and “interest credits”. While it visually mirrors a 401(k) or similar plan, its underlying legal and funding requirements align with traditional defined benefit pensions. These plans offer a clear and understandable way for employees to track their potential retirement income, even though the actual investments are managed collectively.

Employer’s Role in Cash Balance Plan Contributions

Employers are solely responsible for making all contributions to a cash balance plan. This means the employer bears the full investment risk associated with the plan’s assets; increases or decreases in the value of the plan’s investments do not directly impact the benefit amounts promised to participants. The employer is legally obligated to ensure the plan has sufficient assets to meet future benefit payments, regardless of market performance.

Employers often choose to offer cash balance plans due to various advantages, including significant tax benefits. Contributions made by the employer are tax-deductible, which can substantially reduce the company’s taxable income. These plans can also serve as a powerful tool for attracting and retaining talent by providing a robust and guaranteed retirement benefit that distinguishes them from many other employer-sponsored plans. Furthermore, for business owners, these plans allow for much higher tax-deferred contributions than traditional defined contribution plans, offering an accelerated path to retirement savings.

Employee Contribution Considerations

Employees typically do not make direct contributions to a cash balance plan. The “account” they see is a hypothetical record of their accumulated benefit, not an actual investment account that they fund with their own wages. This distinguishes cash balance plans from defined contribution plans, such as 401(k)s, where employee contributions are a fundamental component.

Pay credits are usually a percentage of the employee’s compensation or a fixed dollar amount, while interest credits are based on a fixed rate or an index, such as the 30-year Treasury yield. This structure means employees are shielded from investment risk, as the employer guarantees the credited interest rate regardless of the plan’s actual investment performance.

Determining and Funding Cash Balance Plan Contributions

The amounts an employer contributes to a cash balance plan are complex and determined through an actuarial valuation process. Pension actuaries calculate these contributions based on factors like employee demographics, the promised “pay credits” and “interest credits” outlined in the plan document, and the plan’s investment performance.

Contributions are made to a pooled trust that holds the plan’s assets collectively, not to individual accounts for each employee. The employer is responsible for funding this trust to meet regulatory requirements, including minimum funding standards set by the Employee Retirement Income Security Act (ERISA) and IRS rules. If the plan’s investments perform poorly, the employer must increase contributions to make up any shortfall and maintain the promised benefit levels.

The actuary also certifies the employer’s annual tax deduction for contributions, which is filed with the IRS on Schedule SB of Form 5500. While there is a minimum annual contribution, employers often have a range within which they can contribute, allowing some flexibility based on business profitability, though consistent funding is generally expected for these long-term plans. This intricate process ensures the long-term solvency of the plan and the security of employee benefits.