A cash balance plan is a type of retirement savings plan that combines features of both traditional pension plans and 401(k) plans, offering a unique approach to retirement savings. Unlike a traditional pension plan, where benefits are defined by a formula based on salary and years of service, a cash balance plan credits a participant’s account with a set percentage of their yearly compensation plus interest charges. This structure provides a more predictable benefit, similar to a 401(k), but with the added security of a defined benefit plan.
A financial advisor can help you create a financial plan for your retirement needs and goals.
What Is a Cash Balance Plan?
In a cash balance plan, a participating employee is told that he or she will have access to a certain sum upon reaching retirement. Let’s say that the sum is $400,000. To get to $400,000, the plan assumes a combination of employer contributions and compound interest over time. When the employee retires, she can either take the $400,000 as a lump sum or commit to an annuity that pays a portion of the $400,000 in regular checks.
For each year that an employee earns benefits with a company, she accrues benefits according to the following formula:
Annual Benefit = (Wage x Pay Credit Rate) + (Account Balance x Interest Credit Rate)
Let’s break down those terms. An employee’s wage is his or her salary. The pay credit rate is the percentage of the employee’s wage that the employer provides in contributions. This is often between 5% and 8%.
The account balance is what the employee has already accrued in benefits and earnings. The interest credit rate is a percentage that the employer sets for the growth of contributions over time. This could either be a fixed rate (5%, say) or a variable rate that’s tied to something else, like the interest rate on 30-year Treasury bonds.
If you have a cash balance plan through your employer, you have the choice between annuitizing your benefits and receiving your benefits as a lump sum. If you choose an annuity, your cash balance will be paid out to you in smaller portions in the years after you retire. If you decide to take a lump sum payment, you can choose to take all the money at once and roll it over, either to an IRA or to a new employer’s plan.
Cash Balance Plans vs. Traditional Pensions

Cash balance plans gained popularity when some companies and state governments began converting their traditional pension plans to cash balance plans as an alternative to freezing struggling pensions. If you’ve just received news that your pension is becoming a cash balance plan, here’s what you need to know:
- The benefits you’ve already earned are likely safe: While companies stay afloat, they can change or freeze a pension plan but they can’t renege on benefits their employees have already earned. Even if the terms of your employer-sponsored plan change for the worse, you’ll still have access to the benefits you accrued under the original plan. Plus, most of the funds in the majority of defined benefit plans are federally insured through the Pension Benefit Guaranty Corporation, a government agency.
- Conversion to a cash balance plan is more favorable to younger employees: A traditional pension calculates your retirement benefits using a formula based on your time with the company and you salary in your last few years of employment. If you’re an experienced worker who has climbed the ranks and is now earning well, it’s probably in your interest to have a pension that reflects that wage growth. Cash balance plans, on the other hand, offer benefits that are more evenly spaced over the length of a worker’s career and that grow at the same rate over time. Dollars contributed early in a worker’s career have more time to compound, and therefore are more valuable.
For those considering their retirement options, understanding the differences between cash balance plans and traditional pensions is crucial. By weighing the pros and cons of each, individuals can make informed decisions that best suit their financial needs and retirement goals. Engaging with a financial advisor can provide additional insights and guidance tailored to individual circumstances.
Cash Balance Plans vs. 401(k)s
A 401(k) is strictly a defined contribution (DC) plan, whereas a cash balance plan is considered, depending on whom you ask, to be either a Defined Benefit (DB) plan or a hybrid DB-DC plan. With a 401(k), an employee makes contributions to a retirement plan. The employer sponsoring the 401(k) may or may not make matching contributions.
Here’s the big difference between a 401(k) and a cash balance plan: With a 401(k), the money that the employee will have in retirement is not “defined.” Instead, the employee’s retirement benefits depend on the performance of the market and of the funds that hold the 401(k) contributions. The employee bears the risk that a market downturn will wipe out her 401(k).
With a cash balance plan, on the other hand, the amount of money an employee can expect in retirement is “defined.” That’s what makes it a defined benefit plan. The employer, not the employee, bears the risk of market fluctuations. By their defined benefit status, cash balance plans are insured and must offer the option of a lifetime annuity, neither of which holds for 401(k)s.
Cash Balance Plans for Business Owners

State governments and large firms get lots of media attention when they decide to convert from a traditional pension plan to a cash balance plan. Small and medium-sized businesses, though, can also benefit from using a cash balance plan.
If you’re a business owner, establishing a cash balance plan for yourself and your employees leaves you with much higher contribution limits than you’d get with a 401(k). This can be a real lifesaver if you (or any of your employees) need to make sizable catch-up contributions to prepare for retirement. The contribution limits for cash balance plans are based on age and up to $341,000 in 2025 for workers 50 and over.
Plus, contributions to your business’s cash balance plan reduce your taxable income. You could even set up a 401(k) and a cash balance plan if you want to kick things into gear. Just expect to pay higher administrative costs for the cash balance plan because it requires actuarial certification each year.
Bottom Line
A cash balance plan is an increasingly popular retirement savings option that combines features of both traditional pension plans and 401(k) plans. As more individuals and businesses seek flexible and reliable retirement solutions, understanding the nuances of a cash balance plan becomes essential. This type of plan offers the security of a defined benefit plan, where the employer guarantees a specific retirement benefit amount, while also providing the portability and individual account features similar to a 401(k). Participants benefit from predictable growth, as the plan credits a participant’s account with a set percentage of their yearly compensation plus interest charges.
Tips for Getting Retirement Ready
- A financial advisor could help you set and keep track of your retirement goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Figure out how much you’ll need to save to retire comfortably. An easy way to get ahead on saving for retirement is by taking advantage of employer 401(k) matching.
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