Best practices in cash balance plan design

Executive summary

The “Gold Standard in Public Retirement System Design Series” reviews the best practices of public pensions and provides a design framework for states struggling under burdening post-employment benefit debt. This entry in the Gold Standard series will look at cash balance plans, which have seen a recent uptick in adoption over the past few years. This brief examines the best practices for implementing a successful cash balance plan, as well as exploring the offerings of cash balance pension plans across the country.

This analysis reveals that the stability and adequacy of cash balance plans are critically determined by specific design choices. The interest crediting formula, in particular, emerges as the central driver of employer risk. While fixed or market-based crediting methods produce funding volatility nearly identical to that of traditional defined benefit plans, this research demonstrates that conditional formulas—such as those tied to funded status or featuring capped market returns—can meaningfully reduce volatility while still supporting sufficient retirement income.

Effective plan design must also be paired with robust funding policies. In most scenarios, contribution rates between 12% and 20% of pay can achieve full funding and ensure adequate benefits, provided they are coupled with conservative return assumptions and disciplined amortization methods. Open or overly long amortization periods can erode plan solvency even when the underlying benefit structures are designed to be more predictable.

Overly aggressive assumptions in asset smoothing, payroll growth assumptions, and plan maturity mask funding shortfalls and create compounding deficits. These factors, while often overlooked, prove to be as consequential as the benefit formula itself in determining a system’s long-term risk exposure.

A transition to a cash balance structure offers an opportunity to reset actuarial assumptions, enforce strict funding discipline, and improve stakeholder transparency. This modeling concludes that cash balance plans, when constructed with conditional mechanisms and strong funding rules, offer a stable and sustainable framework for public retirement systems.

Introduction

The continued underfunding of U.S. pension systems has put an enormous strain on state and local governments. To combat this, many plan sponsors have begun to look at alternative designs for their retirement systems. One of those designs is the cash balance plan, a type of retirement plan that blends features of traditional defined benefit pensions with elements of defined contribution (DC) plans, offering a notional employer contribution, a guaranteed interest credit, and improved portability for employees. Up until 2012, there were only four public cash balance plans in the entire country. There are now eight such plans, with two of those being adopted since 2020.

Cash balance plans are positioned as an option that meets the needs of plan sponsors who wish to pare down their risk exposure, while still offering their employees a low-maintenance, guaranteed benefit. For a mobile workforce that tends not to spend full careers in government employment, especially in the days of teleworking, cash balance plan portability—on par with DC retirement plans—is attractive. When an employee leaves their employment, for whatever reason, a cash balance plan allows the employee to take the entirety of their contributions, as well as their employer’s, plus the interest gained on those contributions.

Full Report: Best practices in cash balance plan design

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