By any reasonable measure, traditional defined benefit pension plans are on the decline. Both the number of plans and the number of covered individuals have been declining steadily since their peak in the mid-1980s when there were more than 100,000 plans operating. More recently, that number has declined to about 25,000. Not surpsiringly, this decline occurred at the same time as the growing popularity of 401(k) plans. However, some argue that 401(k) plans alone may not be enough to help employees secure their retirement.
For a small but growing number of companies, cash balance plans offer a third alternative. Cash balance plans have existed for many years. However, until relatively recently, regulatory and legal uncertainty kept many companies from adopting these plans. Since cash balance plans have gotten the final stamp of approval from the IRS and the U.S. Department of Labor, their numbers have been increasing.
Compared to the hundreds of thousands of 401(k) plans in existence, cash balance plans remain a relative drop in the bucket. According to the 2012 National Cash Balance Research Report published by Kravitz Inc., the number of cash balance plans increased 21% last year. The most recent IRS data from 2010 shows 7,064 active cash balance plans. Just ten years ago in 2001, that number was 1,337. However, the report found that growth of cash balance plans continues to outpace the growth in any other type of retirement plan.
A cash balance plan is considered to be a hybrid plan with characteristics of both traditional defined benefit pension plans and defined contribution plans, like 401(k) plans. Like a defined benefit pension plan, all financial risk in a cash balance plan remains with the employer. And like 401(k) plan and other defined contribution plans, cash balance plans allow employees to see their earned benefits as an easy-to-understand account balance and these plans also enable benefit portability by allowing departing employees to rollover their balances into another qualified retirement plan.
Here is how cash balance plans work. Each plan participant receives annual credits to their account based on years of service as well as credits based on the participant’s account balance that are calculated using a specific interest rate identified in the plan document. In many cases, this interest rate is tied to a government bond rate.
After experiencing the upheaval in the wake of the 2008/2009 stock market decline, employees would likely embrace the addition of a cash balance plan. For employers, these plans can be a differentiating benefit with predictable costs even though plan contributions are not discretionary.
The Kravitz report notes that after adding a cash balance plan alongside an existing 401(k) plan, the average employer contribution to employee retirement accounts rose to 6% compared to 2.3% of pay for companies with only a 401(k) plan. Interestingly, it is smaller companies that are driving a great deal of cash balance plan growth. The study found that 84% of cash balance plans are in companies with fewer than 100 employees. Even so, cash balance plan growth during the depths of the recession continued at a decent pace at 38% from 2008 through 2010. Finally, the largest number of plans are in California and New York (23% of all cash balance plans are in these two states) and the fastest growth in new plans is occurring in Florida, Texas and Michigan.