Money Balance

Cash Balance Plans Gaining Steam with 401(k) Savers

Money Balance

As workplace retirement plans keep shifting investment decisions to employees, a throwback to traditional pensions is gaining popularity with corporate sponsors of 401(k) and 403(b) plans.

The number of so-called Cash Balance Plans (CPBs) increased by 17% in 2018 from the previous year, according to the 2020 National Cash Balance Research Report. By contrast, the popular 401(k) plan — classified as a type of defined contribution benefit plan — saw its ranks grow by just 2% year-over-year. 

"Cash Balance Plans are clearly the fastest growing area of the U.S. retirement plan marketplace," says Dan Kravitz, the report's author and an executive with FuturePlan, a national third-party administrator and part of retirement plan record-keeping giant Ascensus. 

Since it makes heavy use of government data (specifically IRS Form 5500 filings), this research series typically has a year or two of lag time between compiling the latest figures. Nevertheless, the National Cash Balance report, which was started in 2008 by Kravitz, is still the most comprehensive we've found in this fast-evolving corporate retirement plan marketplace.

The report's research finds the number of these plans being implemented in the U.S. steadily rose from 1,477 in 2001 to a projected 25,040 in 2019. (See chart below.) This represents a 17-fold increase over 18 years, according to Kravitz. 

Meanwhile, Cash Balance Plans have increasingly become a major part of the retirement marketplace. Based on Department of Labor statistics, Kravitz estimates such plans have increased from 3% to 42% of all defined benefit plans. (See chart below.)

"Traditional defined benefit plans have been steadily declining since the mid-1980s," says Kravitz. He credits a number of factors for a decline in traditional pension plans, ranging from "a complex array of risk issues" to "runaway costs" of health insurance and major changes in workforce demographics.

"We've seen a number of larger corporations convert existing defined benefit plans to Cash Balance," says Kravitz. At the same time, he adds, these types of "hybrid" Cash Balance Plans have also become "increasingly popular" with small- to mid-size businesses.

"From the data we monitor, the traditional pension plan clearly isn't the major force in the U.S. that it used to be, especially with smaller business owners," says Kravitz. "The costs of maintaining these as primary retirement savings programs have just gotten too expensive for most companies to afford."

Referred to as defined benefit plans, traditional pensions require employers to handle investment decisions for plan participants. Employers are also responsible for making all contributions to the plan. As a result, a certain guaranteed level of income to participants is assured.

By contrast, defined contribution plans — such as 401(k) and 403(b) savings platforms — provide fund choices but leave most investment decisions to participants. Also, individual workers typically fund at least some of those benefits through their own salary deferrals. The balance is made up by matching contributions as well as any discretionary profit sharing money thrown into the retirement pot by an employer.

In CBPs, employers are able to take advantage of existing tax rules to fund new and separate accounts for each participant, points out Kravitz. "What really makes these types of tax-advantaged accounts attractive to both employers and employees is that they can be funded over-and-above what's being contributed to an existing 401(k) plan," he says.

Since CBPs are characterized by the IRS as a type of defined benefits plan, Kravitz notes that employers are still responsible for making contributions. Those can surpass $300,000 a year per participant, he says, depending on that person's age and role within a company's hierarchy.

In a 401(k) plan, 2021 benefits are typically capped at $64,500 for a participant aged 50 or older. This includes individual contributions, employer matches and profit sharing. For younger investors, that amount is $58,000.

"We really see cash balance plans coming into play when business owners decide they'd like to defer taxes on more of their retirement savings than what's normally allowed in a 401(k) plan," says Jim Norman, a cash balance plan expert at Laguna Hills, Calif.-based third-party administrator Economic Group Pension Services.

The cost of covering employees in a 401(k) profit sharing plan is typically going to require that owners contribute at least 4.5% of their rank-and-file employees' pay who are eligible to participate, he adds.

"But if we add cash balance plans into the mix," says Norman, "contributions can go up for everyone in a very cost-effective manner."

As might be expected, government filings indicate that CBP benefits are skewed to higher-earning owners and top executives. But federal regulations require employers to test their retirement plans to make sure benefits as a percentage of pay are being distributed in a fair manner, notes Norman. 

"We often see contribution rates increase by two- to three-times for rank-and-file employees when their employers implement CBPs to go along with a standalone 401(k) plan," he says.

Indeed, the average 401(k) company contribution has hovered around 3.5% of a plan participant's annual wages, according to Kravitz. Based on his own research, he figures that such a rate increased to 6.9% when paired with a CBP.

The latest round of major federal tax reforms has helped to create more interest for CBPs, suggests Kravitz. The Tax Cuts and Jobs Act, which was passed by Congress in 2017, included a 20% tax deduction for "pass-through" businesses such as S-corporations, partnerships and sole proprietors. 

"So, a lot of small business owners can now contribute to cash balance plans to increase their taxable savings," says Kravitz. "Then, they might also be able to take advantage of the new 20% pass-through tax deduction."


This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Performance may contain both live and back-tested data. Data is provided for illustrative purposes only, it does not represent actual performance of any client portfolio or account and it should not be interpreted as an indication of such performance. IFA Index Portfolios are recommended based on time horizon and risk tolerance. For more information about Index Fund Advisors, Inc, please review our brochure at https://www.adviserinfo.sec.gov/ or visit www.ifa.com.