How do Cash Balance Plans differ from 401(k) plans?
Cash balance plans are defined benefit plans. In contrast, 401(k) plans are a type of defined contribution
plan. There are four major differences between typical cash balance plans and 401(k) plans:
a. Participation - Participation in typical cash balance plans generally does not depend on the workers
contributing part of their compensation to the plan; however, participation in a 401(k) plan does
depend, in whole or in part, on an employee choosing to make a contribution to the plan.
b. Investment Risks - The investments of cash balance plans are managed by the employer or an
investment manager appointed by the employer. The employer bears the risks of the investments.
Increases and decreases in the value of the plan's investments do not directly affect the benefit amounts
promised to participants. By contrast, 401(k) plans often permit participants to direct their own
investments within certain categories. Under 401(k) plans, participants bear the risks and rewards of
investment choices.
c. Life Annuities - Unlike 401(k) plans, cash balance plans are required to offer employees the ability to
receive their benefits in the form of lifetime annuities.
d. Federal Guarantee - Since they are defined benefit plans, the benefits promised by cash balance plans
are usually insured by a federal agency, the Pension Benefit Guaranty Corporation (PBGC). If a
defined benefit plan is terminated with insufficient funds to pay all promised benefits, the PBGC has
authority to assume trusteeship of the plan and to begin to pay pension benefits up to the limits set by
law. Defined contribution plans, including 401(k) plans, are not insured by the PBGC.
Is there a federal pension law that governs these plans?
Yes. Federal law, including the Employee Retirement Income Security Act (ERISA), the Age Discrimination in
Employment Act (ADEA), and the Internal Revenue Code (IRC), provides certain protections for the
employee benefits of participants in private sector pension plans.
If your employer offers a pension plan, the law sets standards for fiduciary responsibility, participation, vesting
(the minimum time a participant must generally be employed by the employer to earn a legal right to benefits),
benefit accrual and funding. The law also requires plans to give basic information to workers and retirees. The
IRC establishes additional tax qualification requirements, including rules aimed at ensuring that proportionate
benefits are provided to a sufficiently broad-based employee population.
The Department of Labor, the Equal Employment Opportunity Commission (EEOC), and the
IRS/Department of the Treasury have responsibilities in overseeing and enforcing the provisions of the law.
Generally, the Department of Labor focuses on the fiduciary responsibilities, employee rights, and reporting
and disclosure requirements under the law, while the EEOC concentrates on the portions of the law relating to
age discriminatory employment practices. The IRS/Department of the Treasury generally focuses on the
standards set by the law for plans to qualify for tax preferences.
Are there requirements that apply if my employer converts my current plan to a Cash Balance Plan?
Yes; however, employers are not required to establish pension plans for their employees because the private
pension system is voluntary. In addition, employers are allowed substantial flexibility in deciding whether to
terminate or amend their existing plans. Therefore, employers generally may change by plan amendment their
traditional pension plans and the benefit formulas they use.
Federal law does place restrictions on plan changes generally. For example, advance notification to plan
participants is required if, as a result of the amendment, the rate that plan participants may earn benefits in the
future is significantly reduced. Additionally, there are other legal requirements that have to be satisfied,
including prohibitions against age discrimination. In addition, while employers may amend their plans to cease
future benefits or reduce the rate at which future benefits are earned, they generally are prohibited from
reducing the benefits that participants have already earned. In other words, an employee generally may not
receive less than his or her accrued benefit under the plan formula at the effective date of the amendment. For