Hybrid Retirement Plans

Pension experts are exploring the potential for hybrid retirement plans. These plans would combine features of defined benefit (DB) and defined contribution (DC) plans to better distribute investment, interest, and longevity risks between the plan sponsor and the participant. One such hybrid plan is a cash balance plan under which employers credit a participant's account with a set percentage of their yearly compensation. In some cases, employees also contribute. The account grows by a pre-set percentage each year. On retirement, the account can be taken as either a lump sum or as an annuity, sometimes based on a set formula. Unlike a 401(k) plan, investments are managed collectively, and benefits are not tied to the performance of the plan’s investments. 

The conversion of a traditional defined benefit plan to a cash balance plan can negatively affect older workers. Traditional DB plans often base the benefit calculation on the salary in the worker’s final years. These are generally those with the highest earnings. In contrast, benefits in a cash balance plan are based on all working years, including early years when the worker’s salary was lower. As a result, older, longer-serving employees may work for many years after a plan conversion without receiving additional pension credits under the new cash balance plan. This effect is often called wear-away.