A defined benefit plan that works like a defined contribution plan: A possible path forward

With some policy reforms, market-based cash balance plans could offer companies an attractive alternative to traditional pension plans and defined contribution (DC) plans.

For many years, conventional wisdom has held that the corporate defined benefit (DB) plan system is in a gradual decline that will inevitably lead to extinction. It seems the only uncertainty is the rate of that decline and the form of each company’s transition to a purely DC approach.

We question whether that conventional wisdom is correct. Contrary to the notion that the corporate DB system is in a death spiral, there is an alternative that could slow the decline or even lead to additional growth: A type of a DB plan known as a market-based cash balance plan.

These plans eliminate many of the negatives driving employers out of the DB plan system and offer advantages over DC plans. To date, regulatory issues have slowed the adoption of market-based cash balance plans, but potential policy changes could eliminate those barriers and attract more employers to this alternative DB solution.

How market-based cash balance plans work

A market-based cash balance plan provides interest credits based on the rate of return on plan assets, subject to the statutory capital preservation rule. That rule requires employers to offer participants a lump sum benefit at least equal to the sum of the contribution amounts credited to their accounts.

For example, assume that a participant earns exactly $100,000 for 10 years and is in a market-based cash balance plan that provides 5% contribution credits, meaning she receives a total of $50,000 in credits over 10 years. The participant would receive the greater of the $50,000 in contribution credits over the 10-year period (the capital preservation rule) or the $50,000 in contribution credits adjusted by the plan’s actual earnings on those credits over 10 years. Unless the market endures extended stretches of negative returns, the capital preservation rule will have limited impact and this type of market-based cash balance plan will function effectively as a DC plan, but with participants receiving the advantages of professional asset management.

Market-based cash balance plans have exploded in popularity in recent years among smaller employers, such as law firms and doctors’ offices, because they allow companies to contribute far more on behalf of higher paid employees than a DC plan. The maximum contribution on behalf of any employee to a DC plan for 2025 is generally $70,000 (plus $7,500 catch-up contributions for employees over age 50 or $11,250 for employees between 60 and 63). The limits on cash balance plan credits for higher paid employees vary widely based on age but can routinely exceed $200,000 or $300,000.

This far higher limit—which is separate from and does not affect how much employees can contribute to a DC plan—has made market-based cash balance plans especially popular with professional organizations. But market-based cash balance plans have started to show signs of life in larger companies, too, such as major carriers in the airline industry.¹ And more growth could be on the way, due to potential regulatory developments on the horizon.

Potential policy changes that would eliminate barriers to adoption

An often-overlooked provision in SECURE 2.0 has already eliminated one artificial barrier to market-based cash balance plans. Before SECURE 2.0, an arcane set of rules prohibiting “backloading” benefits in a DB plan precluded market-based cash balance plans from rewarding older, longer-service employees. Section 348 of SECURE 2.0 rationalized those rules and allows market-based cash balance plans to provide higher contribution credits to older or longer-service employees.

That change leaves two main challenges for companies offering cash balance plans: uncertainty regarding their accounting treatment and negative treatment for funding and Pension Benefit Guaranty Corporation (PBGC) premium purposes.

1. Accounting uncertainty

Uncertainty around the proper way to calculate liabilities for accounting purposes has been a major impediment to the growth of market-based cash balance plans, because it creates the potential for companies to take on artificially inflated liabilities for accounting purposes.

For example, assume that a company has a market-based cash balance plan with a total of $1 billion in account balances. Since participants generally take their benefit in the form of a lump sum, one might assume that for accounting purposes, the company has a liability of $1 billion. However, the Financial Accounting Standards Board's (FASB) guidance on this issue is not clear, and large accounting firms differ on whether this interpretation is valid or whether companies should instead follow the general approach to valuing non-market-based cash balance plan liabilities.

In that method, each participant’s account balance is projected to normal retirement age based on the expected rate of return on plan assets and then discounted back to present value using the FASB discounting rate, such as a corporate bond yield curve. However, if the plan’s expected rate of return is higher than the discount rate—such as a projected 6% rate of return and a 4% discount rate—then the liability for accounting purposes would end up higher than $1 billion.

FASB’s Emerging Issues Task Force has recognized the lack of clarity on this issue and has recommended changes to address the potential problem—namely, that market-based cash balance plans should use the expected rate of return as the discount rate.² In our example, that would mean projecting the $1 billion in total account balances to normal retirement age at 6% and then discounting it back to the measurement date at 6%, resulting in a far more rational $1 billion liability.

We don’t know exactly when FASB will take action on this recommendation, but the issue may be addressed in the relatively near future because there is growing consensus that the current guidance is inadequate at best.

2. Negative treatment for funding and PBGC premium purposes

The rules for determining an employer’s funding and PBGC premium obligations for market-based cash balance plans are clear. Unfortunately, those rules adversely affect employers offering such plans.

Federal regulations require all cash balance plans to determine their funding obligation by projecting the account balance to the expected payment date based on expected future interest credits, and then discounting that future value to the current date based on statutorily required corporate bond rates.³ As with the accounting uncertainty described above, this process has plan sponsors using different rates to project future liabilities and then discount that figure back to a present value. A discount rate that’s lower than the rate of projected returns will result in a liability that is larger than actual account balances—even if participants are expected to elect a lump sum upon retirement.⁴

A similar anomaly applies to the process of calculating a cash balance plan’s funded status under the PBGC variable rate premium rules. PBGC permits two ways to determine such funded status, both of which have the same flaw. In both cases, the value of the vested account balances is projected forward to the expected payment date under the plan’s funding rules. Then, plan sponsors can use a discount rate based on corporate bond rates over a one-month period or a two-year period.⁵ Either way comes with the same potential for liabilities that are much higher than the sum of the account balances, creating an artificial underfunded status that would inappropriately impact PBGC variable rate premiums.

At this point, there is no active public policy dialogue around changing the funding and PBGC variable rate premium rules to conform to economic reality for market-based cash balance plans. However, with FASB on a path to possibly revisiting the accounting guidance issue, there is potential for regulators to similarly rationalize the funding and PBGC premium rules. We are keeping a close eye on this issue because reform is very much needed.

The future of market-based cash balance plans

Most companies have moved toward DC plans for their retirement benefits—and that is not going to change. However, we don’t believe this shift means that the corporate DB system will disappear entirely.

Potential reforms could rationalize the accounting, funding, and PBGC premium treatment of market-based cash balance plans. These changes would eliminate some of the key issues driving employers out of the DB plan system, such as balance sheet liability management, funding volatility, PBGC premiums, and accounting and earnings volatility.

With these improvements, we may see market-based cash balance plans become broadly popular outside of the smaller professional organizations that have eagerly embraced them so far—helping extend the life of the corporate DB system to future generations of employees. That’s why we will be carefully watching potential policy changes around market-based cash balance plans to help companies determine whether this solution makes sense for their own benefits strategy and participant base.