Critical Point episode 61

Cash balance plans: Why small businesses and professional services firms are adding this retirement benefit

7 July 2025

Transcript

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Kyle Hughes: Hello and welcome to Critical Point, brought to you by Milliman. I’m Kyle Hughes. I’m a principal within our employee benefit practice, and I’ll be your host today. On this episode of Critical Point, we’re going to talk about cash balance plans, a form of defined benefit (DB) retirement plan that’s increasingly popular.

While many companies froze their traditional DB plans many decades ago, these days we’re seeing a resurgence of new cash balance plans. Today, we’ll talk about the reasons for this growth, how cash balance plans work, and why they’re particularly appealing to professional service firms such as medical practices and law firms.

I have a couple of cash balance plan experts who are joining me for today’s conversation. Mike Peatrowsky, a Milliman principal and consulting actuary based in Omaha. Hi, Mike.

Mike Peatrowsky: Thanks, Kyle, for having me today.

Kyle Hughes: And Scott Preppernau, a principal and consulting actuary in Portland, Oregon. Hello, Scott.

Scott Preppernau: Hi, Kyle.

Kyle Hughes: Thank you both for being here. Let’s jump in.

Mike, I’m going to start with you. Why don’t you explain a little bit about what exactly a cash balance plan is and how it works?

Cash balance overview: A DB plan that feels like a 401(k)

Mike Peatrowsky: A cash balance plan is a type of defined benefit plan, but it looks and feels more like a 401(k) plan. So I think cash balance plans are easier for participants and employers to understand, because they have typically more knowledge with a 401(k) plan and how those types of plans work.

So under a cash balance plan, a participant’s benefit is a hypothetical account balance that grows each year based really on two things: one, pay credits, and the other thing, interest credits. Both of these pieces are spelled out in the plan provisions in the plan documents of a cash balance plan, and plan sponsors have a pretty good flexibility in defining how they work.

Pay credits are new contributions to the accounts each year, often specified as a percent of pay, or they can be a flat dollar amount or a combination of both. So, for example, a typical pay credit could be 10% of pay.

Interest credits are what defines how the account balances grow each year. They could be a fixed rate, say 4 or 5%, but also could be tied to something like return on plan assets or some kind of bond, like 30-year Treasury rates.

The hypothetical account balance is tracked and grows over a participant’s career, and when they retire they’re paid out of their account, or, if they prefer, they can convert it to an annuity option. And it works just like a 401(k) plan. So you have the option to roll it over into a traditional IRA, or take the distribution in cash and pay federal and state taxes if applicable at the time of distribution.

Kyle Hughes: Oh, very nice. Scott, anything you would add to that?

Scott Preppernau: Just that, as Mike mentioned there, one of the virtues of it is that there is a lot of flexibility in how a sponsor designs those different elements so they can really target goals that are appropriate for their population and what they’re trying to achieve. And then from the participant side, it is oftentimes kind of easier for them to understand and for employers to communicate than a traditional defined benefit where you’re trying to get across the value of a monthly annuity that’s payable for life, for example, which is a lot harder for a participant to maybe understand and appreciate and value relative to the rest of their kind of compensation.

What’s driving the growth in cash balance retirement plans?

Kyle Hughes: That’s a great segue to my next question, Scott. So I hear, or I read a lot in the news, about a resurgence of defined benefit plans. But at the same time you also hear how defined benefit plans are going away. So, in your opinion, Scott, what’s driving that growth? Or why has there been a perception that maybe defined benefit plans have been declining?

Scott Preppernau: Yeah. And I think for a number of years, the more old-school, traditional defined benefit plans have been declining, at least in certain spaces. I mean, there’s still strongholds where they’re around. But the growth that has been present more in recent years has been in types of hybrid plans, including cash balance plans, which have some of the virtues of both defined benefit and defined contribution plans, kind of trying to get the best of both worlds.

So for a cash balance plan, while these designs have been around for decades, they’ve been growing a lot more really just in the last 10 or 15 years, where there’s been more regulatory certainty on a few points that in the earlier years were still kind of up in the air. And so they have been growing a lot with particular types of sponsors, and the motivations can vary a little bit.

For some plan sponsors, this is a way to get some of the virtues of a traditional defined benefit plan that they can provide for their participants, but to do it potentially with a design that they can choose with a lot less risk. They could take less investment risk. They can share the upside and downside with participants more than they can in a traditional defined benefit plan. And the fact that there is a lot of flexibility in sort of how to structure this is appealing to employers.

The other kind of key type of employer that this can really be helpful for is for those with a high-paid workforce. It can be hard to accumulate kind of the target level of retirement savings you’d want in just a 401(k) or just a defined contribution context because of some limits in those plans. So pairing up a 401(k) plan along with a cash balance plan is a good way to let those savers build up more for retirement over their working career.

Kyle Hughes: Mike, let me ask you just to follow on to that. I’ve read even something around 1,000 new cash balance plans have been getting established the past five to seven years. Is that accurate? And would you agree with some of the points that Scott made in terms of what’s driving that growth?

Why cash balance plans appeal to small-business owners

Mike Peatrowsky: Yeah, that is accurate, Kyle. Over the last probably 15 years, the number of cash balance plans went from, say, around 1,000 to there’s probably 25,000 or more cash balance plans in existence today. So the growth rate is actually growing higher than new 401(k) plans that are being implemented.

And I think the reason for that is small employers are looking at this because, you know, they spent their careers investing into their companies, etc., and maybe not saving for retirement, and, like Scott mentioned, they have a shorter window to build up a retirement fund and a 401(k) just isn’t enough for them. They don’t get the time value of money that younger employees could take advantage of if they started saving in their twenties or early thirties, right? They’re typically in their mid-fifties.

Kyle Hughes: Just for those that may not be as familiar, what are the limits for a 401(k) plan? I know Scott had mentioned that you had mentioned that some high earners are looking to cash balance plans due to those limits. Can you guys just share that for everyone?

Mike Peatrowsky: Yeah, so for 2025, the limit that you can put in between employer and employee money in a 401(k) is $70,000. They also have the ability to put in an extra $7,500 into a 401(k) as a catch-up contribution if you’re over age 50.

Now, a cash balance plan is based on defined benefit plan limits, so it’s more of an age-based calculation. So the younger you are, the lower the limit, but the older you are, the higher the limit can go. From a deferral perspective, an owner that’s in their early 30s could maybe put away $90,000 in a cash balance plan, all the way up to somebody who’s 65 could put in in excess of $300,000 to a cash balance plan.

And a cash balance plan is usually added on top of the 401(k) plan. So for owners, they’re taking advantage of really the limits under the 401(k) plan and the limits under the cash balance plan, so for an owner who’s highly compensated, they could potentially put away $400,000 a year if they added a cash balance plan on top of their 401(k) plan.

So I think, especially in the small space, that’s very attractive for business owners. You are looking for one, tax deferral; two, to accumulate savings in a tax-deferred vehicle.

Why cash balance plans are suited to professional services groups

Kyle Hughes: Thanks, Mike, that was very helpful. I want to take a maybe a little bit of a deeper dive based upon what you said, and a point Scott made earlier, that part of this growth is high earners. Is there certain industries that you’re seeing this really take advantage of the cash balance and the new designs that have come, from your experience working with your clients?

Scott Preppernau: Yeah. So I think, in addition to Mike’s good point about owners who’ve kind of set up a business and then are trying to make up retirement savings later in their career, there’s also a lot of professional groups where, by the nature of the employment, you may have a shorter retirement savings window.

So doctors, lawyers, pilots are all good examples of this, where there’s a big training period at the beginning of a career, so you don’t necessarily get to a position where you can put much away for retirement until later ages than a lot of the kind of general population. And then for some of these there’s also kind of curtailed endpoint of the career. Pilots can only work so long, given some of the rules governing the profession, and so it does make for a shorter window, and by the nature of being a high-paid group, it’s harder to put away as big a percentage of pay over their shorter working career.

One additional limit that kind of factors in for this group is that year by year there’s only so much pay that can be included in a qualified plan. And so for currently for 2025, it’s $350,000. But for someone who earns well above that, even if they’re getting 10% of pay in their qualified defined contribution plan like a 401(k), they’re not really getting 10% of their full pay.

And so, combine that with a shorter working career, and they may not be able to provide kind of the replacement ratio that’s recommended in retirement on a 401(k) by itself. And so that’s where a cash balance plan can help you structure to kind of fit with a population that runs into the pay limits and has a shorter working career and can help them get an adequate retirement savings built up over that working period.

Cash balance plan designs for small firms

Kyle Hughes: So really, certain industries that it makes sense. But it’s also a lot of small professional service firms and a lot of large organizations as well that have high earners. So what types of differences would you see in a cash balance plan depending on if you were working with a small, say, law firm or doctors group versus a larger organization, whether it be professional service or not?

Mike Peatrowsky: I can talk a little bit about small business, Kyle. That’s where I spend the majority of my career is in working with small businesses. What you see there typically is, you’re typically looking to maximize the owner to the extent that cash flow will allow. So typically you would get census in, you would look at the demographics of their employees, and then design a plan around that particular owner.

That may be a flat benefit, that may be some type of percent of pay. But that percent of pay is going to be a pretty high percent. Typically in a larger employer, you might just have a 10% cash balance benefit. With a small business, you maybe have a couple of owners where they have different tiers, like one may want to do 80% of their comp, one may want to do 50% of their comp, one may want to do 20% of their comp.

So that’s kind of the flexibility, and we look at the plan design as really one of the most critical pieces of the cash balance world. Because you don’t want to put a plan in place that doesn’t fit for that owner, because you don’t want to get them in a situation that they can’t make the required contributions each year to the plan. And so we really just make tailor-made solutions for the business owner and what they want to accomplish with their plan.

And then, typically for the employees, we need to give an amount that provides them with a meaningful benefit under the cash balance plan so we can pass all the required non-discrimination testing and coverage, etc. And that’s typically then paired with the 401(k) plan. So if you put a cash balance plan in place, typically for employers they need to put in additional dollars for their employees, which benefits the employees as well. So it’s kind of a win-win for both the employer and the employees.

I’ll turn it over to Scott, and he can kind of walk you through the design differences on the large plans.

Cash balance plans customized for large organizations

Scott Preppernau: Thanks, Mike. Yeah. Larger plans, since they’re working for bigger populations, a lot of times the design’s a little bit simpler and not as customized to the needs of just specific subsets of the population. But there still is a fair bit of flexibility, and sponsors can choose really what helps them meet their goals.

So if you’ve got a big rank-and-file population, it might be that, say, the pay credit is just a flat 10%: really easy to communicate, easy for people to think of relative to what they might be getting in a defined contribution also, and so that works great. But a sponsor can also choose if they do want to incentivize retention or provide something that’s more of a bigger benefit later in a working career. You can do that by giving a tiered benefit. So maybe at the initial hire, the pay credit is 5% and then goes up to 7% and goes up to 9% at different service thresholds over the course of a working career. That helps build both a retention incentive, and it helps sort of mimic the structure of a traditional defined benefit plan in providing larger benefits for those who are closer to retirement.

The other kind of big avenue there, the interest credit, is one that gets a lot of attention in that a sponsor will want to choose whether they’re just giving a flat same percentage every year that they’re trying to credit to their employees or have something that’s more variable, including what we call a market-based cash balance plan, where what they’re really doing is passing along the return of the assets underlying the plan to the participants each year. So participants get the upside and the downside in general for the actual investment returns of the plan. There is a protection on the downside, in that participants by rule for cash balance plans can’t get less than a 0% return over their working career. So they do have a floor. But that lets participants share in the investment experience and prevents employers from being on the hook for significant changes in cost or funded status based on investment returns over either the shorter or the long term.

Mike Peatrowsky: Yeah. And just to follow up on Scott’s point, Kyle, larger employers are the ones that you typically see the market-based interest credits, where you’re returning based on underlying plan assets. In the smaller plan space, you typically see employers pick a flat crediting rate. And the reason for doing that is because that’s the rate that you have to use for nondiscrimination testing purposes. So that helps reduce the volatility of contributions, the amount of contributions that need to be made each year. When it’s level and the demographics are level, you can kind of expect what you’re going to contribute each year.

Market-based cash balance plans match employers’ risk tolerance

Kyle Hughes: Thanks. You guys use the term “market-based cash balance plan,” and this is probably five or six or seven years ago, one of the pushbacks that sometimes we would hear from people around cash balance plans was, it was more of a mechanism to allow high earners to shield taxes because they weren’t really earning market returns. It was they were earning some type of an interest credit that was paid. But is the market-based cash balance plan, is that kind of a new design that has come to market and gives more ability to allow for more returns similar to a 401(k) plan? I’m just curious to get both your takes on that.

Scott Preppernau: Sure, Kyle. So this is one area where, I think as I mentioned earlier, there was regulation 10 to 15 years ago that helped clarify some key aspects of cash balance plans. This is one that was very much on the docket of that regulation. So up until then there had been more question about exactly how some of the rules around market-based cash balance plans can apply. So there’s a lot more clarity, and it’s become a lot more popular with that.

And it just is, given the reasons that some sponsors left traditional defined benefit plans, one of the big risks that are hard to manage in those plans is, as a plan gets larger, investment risk just gets larger and larger, and it doesn’t become any easier to manage with a bigger pool of assets. Unlike, for example, longevity risk, which gets easier to manage for a bigger population than it is at an individual level. So by creating a market-based cash balance plan, that investment risk really is shared between the employer and the employees, and that kind of cuts both ways. It’s both upside and downside, but it lets employers offer a defined benefit plan, but a cash balance version of it, and do it in such a way that matches their risk tolerance and lets them not accumulate a level of investment risk that would be hard to stomach over the long term.

Tips for employers considering cash balance plan options

Kyle Hughes: Very helpful. So what other considerations, whether it’s pluses or minuses, should employers keep in mind when they’re looking to establish a new cash balance plan?

Mike Peatrowsky: Good candidates are employers that want increased deductions over several years, have the resources to make them. Employers that are typically professional service groups are not really affected by economic volatility from year to year. They have to be willing to take on additional contributions to employees. Typically that looks like a couple of partners or older business owner that has a younger staff. That’s an ideal situation for somebody looking for additional tax deferral, looking for additional retirement savings.

Obviously the biggest driver for cash balance plans is the ability to put in more than the 401(k) limits that you can put in each year. The other cool part of cash balance plans is that you don’t have to give everybody the same benefit. You can have different benefit levels for different groups of employees. So that’s really a great feature. That’s attractive. Typically, it shields participants from investment risk, and then there’s ways you can mitigate risk by using market-based returns for employers.

The other good thing for professional service groups: It is a qualified plan, so it’s protected from creditors, so any money that they have in the plan is also protected from creditors. So you’re getting tax deferral, you’re getting additional retirement savings, you’re getting creditor protection. I mean, there’s a lot of good things that go into cash balance plans.

What are some of the negatives? You know you are required to put in the level of benefit that you choose when you set it up. Now, a plan can change benefit levels every three to five years. But you kind of want to go into the mindset like, yeah, I can fund this for a certain period of time before I want to make any changes to the plan.

Depending on the size of the plan, it may be covered by the Pension Benefit Guaranty Corporation (PBGC). So there’s additional fees that have to get paid to the PBGC each year. It’s basically a governmental insurance program.

One thing that could be looked at as a negative is, from an employer perspective, you have to have a certain vesting schedule. So your vesting schedule has to be a three-year, 100% vesting or something that vests even faster than that. Typically in your 401(k) plan, you see a graded schedule that you’re not fully vested for six years. You know, 20, 20, 20 up until you get to 100%. But in a cash balance plan, you’re required to vest 100% in three years.

Scott Preppernau: I would just say that, especially for larger employers, if they are thinking about launching a cash balance plan, there’s a number of decisions to think through. And you want to make sure that you’re making all of those plan design choices thoughtfully. We talked about pay credits and interest credits. Those will all kind of have knock-on effects on other elements of the plan, how you’re running the plan, how you’re communicating it to your employees. And so you want to be careful and thoughtful in setting that up because the goal is to set a durable structure that’s going to last and work for you in good times and in bad times.

While you can amend and change these plans in the future, there are certain parts that that’s harder to do than others. And so you really want to try to spend the time, work with advisors, professionals. Figure out how you’re going to administer the plan, how you’re going to roll it out to your employees at the outset, so that you’ve got a structure that you’re going to be happy with.

Cash balance retirement plans in the public sector

Kyle Hughes: Very nice. I did want to take one step back. I know we’ve talked a lot about corporations and small businesses. I was just curious to get y’all’s take: Have you seen cash balance plans being used in a governmental setting or in a multiemployer setting? I know they have been having more traditional defined benefit plans. So even though we’re seeing new cash balance plans in the corporate market, have we seen any other types of organizations moving to a cash balance design, given some of the benefits that you both have spoken of?

Scott Preppernau: Definitely in the public sphere, and especially at the statewide level, a lot of times there are still a lot more traditional defined benefit plans, and part of that is because of the way they can run and operate in the public world as opposed to corporate rules and having a longer timeframe with a state or a municipality. But we do see at least some cases where there have been large either governmental-sponsor states or other sponsors that have introduced new cash balance components to their plan.

Oftentimes in the public world, what’s happening is that those new benefits are applying just to people hired after a certain date. And so then they may come in and have a cash balance plan. A new tier of employees has a cash balance plan and maybe a defined contribution plan side by side. It has more of that kind of structure. But it usually is coming in more prospectively, rather than affecting current employees. So it’s a slower build for a public plan that does this, usually.

How cash balance plans can help recruit and retain employees

Kyle Hughes: Thanks, Scott. I have one more question before we wrap it up. You see, you hear a lot about this retirement crisis that our country is facing. And so, from what I heard from both of you today, some of the new plan designs that have come to market, especially specifically from a cash balance standpoint, seem to help organizations address that. Just what would y’all’s take be for organizations as they’re looking to attract and retain and help their participants be ready for retirement? Any final thoughts in terms of just the benefits of looking at cash balance, in addition to other kind of defined contribution-style plans?

Mike Peatrowsky: Yeah, especially in the smaller plan space, you know, smaller businesses, there’s only so much to go around, right? And to retain and attract great talent and keep that talent around, if they have a cash balance plan, that typically means they also have a fairly rich 401(k) plan. So I think that does help employees. Cash balance plans can really be a great driver, not only in the small business world, but also in large businesses to help attract and retain talent and help with the retirement crisis going forward.

Scott Preppernau: Yep. And I would add that there’s sort of a traditional concept of a three-legged stool, where for a retiree, they may ideally be able to have benefits from Social Security and from employee savings over their working career, and then employer savings as well that comes through some type of employer-provided plan. And really, the appeal of the cash balance plan can be a good avenue for that last category, that employer-provided retirement benefit and savings. And it can be an appealing structure for certain employers that really works well with their population and lets them help their retirees kind of holistically plan for a secure retirement.

Kyle Hughes: Yeah, thanks for sharing that. I want to thank Scott and Mike for joining me today. You can read some related analysis on our website. Go to milliman.com and search for “cash balance plans.”

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