Defined Benefit Plans
Defined Benefit Plans operate, per their name, with a “defined benefit” provided to employees at retirement.
On an annual basis, an actuary determines a minimum required, maximum allowed, and recommended contribution for the employer based on the current plan assets when compared to the current plan liabilities to meet projected retirement benefits. The responsibility for funding the individual liabilities lies with the employer who invests all of the overall plan assets. Investment gains/losses will not affect participants’ benefits but may require smaller or larger contributions by the employer.
Defined Benefit Plans are often appealing to employers who are looking to contribute more than the $66,000 maximum defined contribution limit.
In a DB Plan, the maximum benefit that can be funded for is the lesser of $265,000/yr. for 2023 at retirement or 100% of highest 3-year average compensation.
Substantial deductible contributions are allowed to be made to the plan to create a large enough funding source to fund the accrued benefits.
Cash Balance Plans
A Cash Balance Plan is a type of Defined Benefit Plan that will appear more like a Defined Contribution Plan to participants but operate like a Defined Benefit Plan for funding purposes.
For this reason, these plans are referred to as hybrid plans. Participants will receive a Cash Balance statement with hypothetical balance and earnings, instead of a traditional Defined Benefit statement expressed as a fixed monthly benefit upon retirement.
In a Cash Balance Plan, each employee’s “account” receives an annual contribution credit and an interest credit based on a guaranteed rate as stated in the plan document. An employee’s plan benefit is equal to the hypothetical account balance which represents the sum of all contributions and interest credits. For employees, they can more easily understand their plan benefit and count on a determinable amount that is not affected by market fluctuations for financial planning purposes.
As in a traditional defined benefit plan, the employer in a cash balance plan bears the investment risks and rewards. An actuary will determine the minimum required, maximum allowed, and recommend contribution to keep the plan funded on a termination basis.
Though unlike a traditional DB Plan, the liabilities in a Cash Balance plan are more predictable, since benefits are credited on a year by year basis in relation to the current year and will grow at the plans stated interest rates.
Traditional Defined Benefit Plans
Instead of an individual account balance based on contributions and earnings, a defined benefit plan promises a monthly benefit at retirement funded by a pooled trust.
The benefit formula is stated in the plan document and is generally based on a participant’s average compensation and years of service.