How are cash balance plans different from defined-benefit and defined-contribution plans?

A defined-benefit plan guarantees a specified level of retirement income based on the employee's years of service, age, and earnings level. A defined-contribution plan does not promise a specific benefit level for employees upon retirement. Rather, an individual account is set up for each employee with a guaranteed size of contribution. An increasingly popular way to combine the advantages of defined-benefit plans and defined-contribution plans is to use a cash balance plan. This type of retirement plan consists of individual accounts, as in a 401(k) plan. But in contrast to a 401(k), all the contributions come from the employer. Usually, the employer contributes a percentage of the employee's salary, say, 4 or 5 percent. The money in the cash balance plan earns interest according to a predetermined rate, such as the rate paid on U.S. Treasury bills. This arrangement helps employers plan their contributions and helps employees predict their retirement benefits. If employees change jobs, they generally can roll over the balance into an individual retirement account. Defined-benefit plans are most generous to older employees with many years of service, while cash balance plans are most generous to young employees who will have many years ahead in which to earn interest. For an organization with many experienced employees, switching from a defined-benefit plan can produce great savings in pension benefits. In that case, the older workers are the greatest losers, unless the organization adjusts the program to retain their benefits.