Cash Balance Plan Impact
Recent studies have found that cash balance plans now hold more than $1 trillion in assets. A cash balance plan is a cross between a traditional defined benefit pension plan and a defined contribution plan (such as a 401(k)). Generally, employers contribute a set portion of a participant's salary to the plan each year (a "pay credit", which is usually equal to between 5 and 8 percent annually), and the participant's account will also be credited with an interest credit each year. The employer is required to contribute each year. The interest credit may be variable (for example, it may be tied to a stock index or the 30-year Treasury rate, for example) or fixed. When the participant retires, he or she receives an annuity based upon the amounts that have been credited to his or her account (lump sum options are also permitted).
We asked two professors and authors of Tax Facts with opposing political viewpoints to share their opinions about whether cash balance plans will have a widespread positive impact on retirement readiness.
Below is a summary of the debate that ensued between the two professors.
Their Votes:
Their Reasons:
Byrnes: Absolutely. Cash balance plans have become significantly more popular in recent years, as employers learn about the potential benefits of these hybrid-style retirement savings options. They're only going to continue to grow in popularity as employers learn more about the potential tax-deferral and employee retention benefits of these powerful plans.
Bloink: Cash balance plans aren't going to have a widespread impact on retirement readiness when it comes to rank-and-file employees, at least not anytime soon. Yes, successful high-income business owners will be--and should be--attracted to the cash balance plan model because it allows them to defer significantly more in terms of contributions, providing a powerful avenue toward catching up on retirement savings after years of focusing on investing in a business. That doesn't mean they'll want to adopt these plans in favor of employees.
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Byrnes: We have to remember that cash balance plans allow employers to contribute significantly more to the plan when compared with traditional defined contribution 401(k) plans. Employers seeking to catch up on their own retirement savings while also maximizing the tax deferral potential have been--and will continue to be--extremely attracted to the cash balance plan model.
Bloink: Cash balance plans tend to be more popular in situations involving business owners with few or no employees. We also have to consider the costs and complexities associated with cash balance plans. Actuarial guidance is needed to even calculate the employer's contribution limits. It's simply not feasible to believe that these complex plans are going to gain widespread traction in the workplace.
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Byrnes: We also have to remember that we aren't talking about the troubled defined benefit plan models of the past. Modern cash balance plans are widely tied to market performance, deriving interest credits based on the actual performance of the underlying assets. On the employee side, balances can also be transferred to a new employer's cash balance plan (or even 401(k)) when the employee changes jobs. The benefits really do outweigh the burdens.
Bloink: At the end of the day, employers are looking for administrative simplicity and familiarity when it comes to their retirement plan offerings. Employers aren't going to be interested in introducing these types of complicated hybrid plans into the mix. Yes, cash balance plans offer powerful benefits when they're adopted. The reason they won't have a widespread impact on employee-side retirement readiness is because employers rarely offer them in the first place.