Cash Balance Plan Definition

Cite this article as:"Cash Balance Plan Definition," in The Business Professor, updated March 13, 2019, last accessed October 24, 2020, https://thebusinessprofessor.com/lesson/cash-balance-plan-definition/.

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Cash Balance Plan (CBP) Definition

Cash balance plan CBP refers to a benefit or pension plan that acts similarly as a defined contribution plan.  Similar to a traditional pension, CBP provides the workers with the scheme that provides a lifetime annuity. However, contrary to the pensions, CBP creates an account for an individual employee that has a specified lump sum.  Many companies converted their pension plans to cash balance plans. This is because the scheme provided by the cash balance plan is cheap compared to other plans.

A Little More on Cash Balance Plans

The employees do not prefer the cash balance plan since they consider it to benefit the company at the expense of employees.  The scheme does not allow employees in the professional fields such as Physician to shelter more money from Uncle Sam.

How CBP works

The cash balance plan provides that the companies under the plan should make their annual contribution towards the scheme.  The money contributed to the scheme is invested, and it attracts some percentage of interest which is credited directly to the company`s account. The interest rate usually comes with a fixed percentage rate or variable rate attached to IRS treasury interest.

When the investment yields better interest, the company will channel their investment for future benefits in the reserve account.  On the other hand, when the investment does not yield a good interest, the company will be forced to pull out of reserve account. When the company makes a big loss in its investment, it may be forced to increase their contribution in the subsequent year to increase the savings in the reserves account. Besides, the cash balance plan gives the company an opportunity to amend its plan and make more contribution to individual accounts within the plan. In other words, the company takes investment risks for its employees.

The White Coat Investor’s Cash Balance Plan

The cash balance plan provided by the MedAmerica has a different plan for the partnership business. The Pension Protection Act of 2008 enables the pension plan to pay for the investors and the participants the actual return of the plan rather than that of the IRS treasury rate that fixed a condition that returns cannot be less than zero. The MedAmerica plan has created a cap of 6.5% with surplus earning channeled to reserve account and be drawn in the event of market losses. The surplus money is shared across 8 mutual investment funds. The investment attracts the ratio of 46% / 54% bond/stock ratio. The investment committee makes an annual agreement and decides the best interest to credit to the participants.

When the investment produces low or no return, the interest payment is not credited to the participant account.  However, if the investment generates a higher return, the cap of 6.5 % is credited to the reserve account. When the company contributes more funds to compensate the losses, it can lead to the economic downturn especially when the participants buy low personal accounts. This may make the employee not to get any share of the reserve even in the event of higher return in the previous year.

References for Cash Balance Plan (CBP)

Academic Research for Cash Balance Plan (CBP)

  • Why are firms in the United States abandoning defined benefit plans?, Rauh, J., & Stefanescu, I. (2009). This paper examines the reason behind the terminating or reducing the availability of defined benefits plans by the publicly listed companies in the US between 1998 to 2007. ¬†According to the author, publicly listed companies reduced benefit accruals using ways such as freezes, cash balance conversions, and terminations. While Changing pension plan depends on the financial viability of the sponsor, the total cost benefits do not decrease instantly when the pension plan is frozen. ¬†The only impacts that occur are that the contribution towards a specified contribution plan increases immediately.

Cost shifting and the freezing of corporate pension plans, Rauh, J., Stefanescu, I., & Zeldes, S. (2013). This paper examines the cost shifting and freezing of the company pension plans that have been experienced in the US over the past few years. According to the author, many of the companies in the US has shifted their pension plans from defined benefits (DB) to defined contribution (DC).  The author presents that by comparing the defined benefit and defined plan, it was revealed that DB accruals to the actual increase in 401(k) have partial compensation to employees for the lost DB accruals. In this regard, they give the employee more benefits and seems to be more costly to the companies.

Cash Balance Pension Plans: Good News or Bad News?, Rao, A., Higgins, L., & Taylor, S. (2002). Journal of Applied Business Research, 18(3), 77-82. This paper seeks to determine the viability of the cash balance plan to the corporations and the employees. According to the author, the cash balance plan has both the benefits and drawbacks to corporations as well as the employees. The author presents that CBP provides the workers with a scheme that covers lifetime annuity. However, this creates some challenges to the workers since it has a completely specified lump sum.  For this reason, many corporations have shifted their pension plans to a cash balance plan to reduce the high of pension in other pension plans.

Transition Period of Mandated Accounting Changes‚ÄĒTiming of Adoption and Economic Consequences: The Case of SEAS No. 13, El‚ÄźGazzar, S. M., & Jaggi, B. L. (1997). Journal of Business Finance & Accounting, 24(2), 293-307. This article examines the timing adoption economics SEAS No. 13 Which provide the guidelines to the accounting for lessees and leases. ¬†The study analyses the real debt contract that affects the financial position of the companies and determines whether the accounting for depth are conducted in accordance with the GAAP or Non-GAAP guidelines. ¬†The paper also examines the management actions to improve the negative impacts of complying with SEAS No. 13. The study revealed that the companies that adopted this accounting guideline late experienced higher debt covenants based on the measurement of the GAAP.

Cost saving and the freezing of corporate pension plans, Rauh, J. D., Stefanescu, I., & Zeldes, S. P. (2017). This paper seeks to determine the cost reduction mechanism by freezing a particular company pension plan. According to the authors, many companies tend to freeze DB pension plan because they have higher prospective accruals.  Therefore, it has a higher potential to save cost. The study discovered that the freeze helps in saving the company about 3% of the total payroll cost in the starting year. The authors further state that the payroll cost saving may not have been possible suppose the company used a benchmark model whereby the employees receive the benefits equal to the marginal product and labor market is unregulated.

Giving Teeth to the Prohibitions of ERISA: Forbidden Actuarial Calculations in Cash Balance Plans as per Esden v. Bank of Boston, McLaughlin, G. M. (2000). Tax Law., 54, 835. This paper examines unaccepted actuarial evaluation in the cash balance plan as provided by Esden v. Bank of Boston.  The study presents that Boston bank desecrated the provision of the Employee Retirement Income Security Act (ERISA) it actualized the present equivalent value of the accounts of the participants using less interest credit percentage than minimum guaranteed terms.

A New Hybrid Defined Benefit Plan Design, Dydo, W. E. (2005). This paper examines the newly developed defined benefit plans. According to the authors, the traditionally defined benefit plans can be hard to understand and complex to administer.  However, the Hybrid cash balance plans help the companies and individuals to offset the problems associated with tradition cash balance plan. The authors present that the newly developed defined benefit pension plan makes it easy to communicate with the participants, allows for accrual patterns that closely replicate those of the two most common forms of hybrid pension plans, and avoids the controversial nondiscrimination issues that currently trouble sponsors of hybrid plans.

Pension Protection Act of 2006: Retirement and Estate Planning Opportunities., Milberg, B. R. (2008). Journal of Financial Service Professionals, 62(2). This paper provides an in-depth understanding of the pension protection act of 2006.  The authors present that this act provides the mechanisms through which estate planning opportunities and the retirement benefits can be evaluated and executed.  The act has created significant reforms in the US pension plans. It has also made some provisions regarding the pension including the increased individual retirement account (IRA) contribution limits and increased salary deferral contribution limits to a 401(k)

Compensation and Benefits: Theory to Practice., Purushotham, D. P. (2009). Proceedings of the Northeast Business & Economics Association. This paper presents a theory regarding the compensation and benefits plan. According to the author, as the companies continue to face competitive pressure, they attempt to do more using fewer resources especially human resources. To achieve their objectives with few employees, there is a need to create effective management of human resources.  This includes having a better employee compensation system

The Evolution of NDC Approach in the Social Security’s History of Thoughts and Private Plans [J], Bingwen, Z. (2003). Economic Research Journal, 4, 006. This paper examines the introduction of new Social Security model named NDC (Notional Defined Contribution) in the direct contribution scheme DC scheme. This newly introduced model has a mixture and a hybrid which include Funded DC component in combination with a PAYGO DB scheme.

Cash balance pension plan conversions and the new economy, Coronado, J. L., & Copeland, P. C. (2004). Journal of Pension Economics & Finance, 3(3), 297-314. This paper seeks to estimate the factors in a hierarchical manner their impacts on the conversion of traditional defined benefit to cash balance plan.  The author presents that many companies have converted a traditional defined benefit plan to cash balance plan over the last few years. This is attributed to the combined features of defined benefit and defined contribution plan.

Adopting cash balance pension plans: implications and issues, Clark, R. L., & Schieber, S. J. (2004). Journal of Pension Economics & Finance, 3(3), 271-295. This paper examines the implications and issues related to adopting a cash balance pension plan. According to the author, many companies over the past 15 to 20 years, have converted their traditional defined benefit plans to cash balance or pension equity plans.  This is attributed to the fact that traditionally defined benefit plans specify benefits in terms of an annuity payable at retirement. From the worker’s viewpoint, cash balance and pension equity plans tend to be similar to the defined contribution plans, therefore, has many benefits to them.

How Do Cash Balance Plans Affect the Pension Landscape?, Cahill, K., & Soto, M. (2003). This paper examines the impacts of cash benefit plan on the pension landscape. According to the authors, the pension world has changed considerably over the past decade since the introduction of the cash balance plan. The number of individuals that were covered by the defined benefit plan has dropped considerably while the one covered by contribution plan has improved considerably.

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