Market-Based Plans Are Replacing Their First-Generation Predecessors, and the Market Is Better for It

When pension professionals hear “Cash Balance Plans,” it evokes memories from the last century, of an actuarial trick-turned hybrid pension design that was popular among employers looking to get away from traditional pension plans, and then fell out of favor as the shortcomings became apparent.

But an odd thing has been happening in recent years. Cash Balance Plans are making a resurgence – some in their traditional form, but many more in a next-generation design known as Market-Based Cash Balance Plans, or simply Market-Based Plans. Over the last 10 years, the number of Cash Balance Plans in the U.S. has increased by nearly 70%. At the same time, the number of traditional plans declined by more than 50% (ref. October Three 2026 Cash Balance report). Of these new plans established by employers with more than 100 employees, the majority have been of the new Market-Based vintage.

So what’s happening here? Why the return of Cash Balance Plans, and what is the critical difference between traditional and Market-Based Plans that is driving this renaissance?

Two factors are fueling the shift:

The first is the growing acknowledgement that Defined Contribution (DC) plans, which generally replaced traditional Defined Benefit (DB) plans as the employer-based retirement program of choice, are excellent vehicles for incenting savings but poor vehicles for securing participants’ retirement incomes.

The second is the regulatory development, technological advancement, and increasing acceptance of next-generation Market-Based Cash Balance Plans, which solve the shortcomings of older Cash Balance designs.

The Shortcomings of DC Plans

The driving characteristic of DC pension plans, including the ubiquitous 401(k) and 403(b), is individuality. Employer and/or employee money is remitted to an account assigned to the individual. Investments are often directed by the individual, within a set of curated choices, often chosen for low cost. The account balance grows toward a pre-retirement goal, and ultimately, the accumulated funds are intended to support the individual’s needs in retirement. But secure lifetime incomes are not a feature, and with good reason. An individual-focused program is poorly equipped to protect that individual from the uncertainty of unknown longevity. This issue is discussed in depth in our earlier article on lifetime income. DC plans have struggled to address this problem, and the insurance products designed for this purpose are generally viewed as expensive and unpopular, leaving employers to look for other options.

Comparing First-Generation Cash Balance Plans to DC Plans

At their core, Cash Balance Plans are a hybrid design that introduces DC features to a DB world. Participants earn a benefit in the form of a Pay Credit that accumulates in a notional account in their name. This account grows with an Interest Credit, mimicking the experience of a DC plan. At retirement, the individual is entitled to a lifetime pension that can be “purchased” in exchange for the accumulated balance, at actuarially neutral rates.

This experience feels a lot like a DC plan, but with a few important differences:

• The account balances are notional, not real. There is no specific pool of assets backing up those balances, which are the outcome of a calculation, and which can deviate substantially from the actual assets supporting the benefit, creating surpluses and deficits routinely.

• The growth in the notional accounts is not based on the returns of any specific assets. Rather, they represent a theoretical rate of return – typically either a flat rate (e.g., 4% per year) or the yield on a Treasury security. The IRS places limits on these returns, meaning that long-term growth is typically far lower than a comparable DC plan, making the accumulation side of these plans unattractive to participants.

• The disconnect between the Interest Credit and actual investment returns (it is extremely difficult to hedge the Interest Credits) creates significant financial risk for employers offering these plans. When market returns are poor, these plans typically suffer losses that the plan sponsor must make up for with increased contributions and pension expense, often at the worst possible time. A recent analysis of one such plan showed that in 5 out of 11 past years, the plan’s Interest Credit was greater than the return on plan assets, resulting in losses. DC plans never experience these losses as employee accounts absorb negative returns, ideally to be reversed in better years, without any impact on the employer.

• Offsetting many of these negative impacts, Cash Balance Plans allow participants to “purchase” lifetime income directly from the plan, while DC plans require that purchase to be underwritten by an insurance company. This makes a huge difference to the cost of the benefit. Insurance companies have their own cost structures, expenses, commission loads, and profit margins. The result is that annuities purchased from an insurance company are generally 20%-30% more expensive than those that can be purchased from a Cash Balance plan. That means that for every dollar of lifetime pension that a Cash Balance plan can provide, a DC plan annuity or other DC income product will typically only pay 70 – 80 cents.

These key differences (in addition to other, more minor ones) mean that first-generation Cash Balance Plans deliver lower investment returns for participants and greater financial risk and volatility for employers, in exchange for the advantage of higher lifetime income. One could debate the merits of this trade, but the market has largely spoken by choosing DC plans over first-generation Cash Balance Plans (other than limited situations where the other factors apply, such as the ability to access DB surplus), leading to their decline in popularity.

Enter Market-Based Cash Balance Plans

The new entrant to the space is changing this dynamic. Market-Based Cash Balance Plans are a next-generation design that fixes the problems of first-generation plans by linking the Interest Credits directly to a pool of invested assets – ideally, the actual investments of the plan, calculated and credited on a daily basis. This small-sounding change has profound impacts on investment strategy, participant experience, retirement outcomes, and the overall value of these plans and their growing popularity.

Compared to non-market first-generation Cash Balance Plans:

• Market-Based Plans provide benefit accumulations that are much higher and comparable to, or often greater than, the accumulations of similarly invested DC plans.

• When properly managed, these plans offer employers near-perfect hedging of financial risk, resulting in stable, predictable costs, even when market returns are volatile. In fact, the Financial Accounting Standards Board recently acknowledged the low-risk nature of these plans and is in the process of amending pension accounting standards specifically for Market-Based Cash Balance Plans, so that financial reporting will properly reflect the low-risk nature of these plans.

• They retain the Cash Balance plan’s ability to provide lifetime income inside the plan at substantially lower costs than an insured product, but now apply this cost advantage to the much larger balances that these plans accumulate, making them a much more important part of your retirement strategy.

In summary, Market-Based Plans retain the advantages of traditional Cash Balance Plans, but fix the shortcomings, creating a plan design that delivers greater benefits and lower employer risk than first-generation plans, and simultaneously higher lifetime income than DC plans. A true best-of-both-worlds design.

The growing interest in these designs is coming both from employers who previously sponsored first-generation Cash Balance Plans who see Market-Based Plans as the solution to the challenges of the old designs, and from employers who have been struggling with the shortcomings of DC-only programs and looking to Market-Based Plans as a supplement their existing programs, pairing the 401(k)’s flexibility with the security and lifetime income of Market-Based Plans. In either case, this trend is growing and represents a big step forward in the evolution of the U.S. Pension Market.