Reducing costs through Cash-Balance pension plan

A cash-balance pension plan that tailors benefits according to a predetermined benefit formula for young and upwardly mobile employees and organisations 

A recent study of the US software industry reveals that many companies have adopted a new employee pension benefits scheme for their employees. The change has been precipitated by the high employee turnover in the software industry.

Indian Schemes

In India, pension schemes like Approved Superannuation Funds (ASF) work under the Income -Tax Act and Rules. They are of two types:

• Defined benefit scheme
• Defined contribution scheme

Most Indian companies follow the defined benefit scheme in. An employer defines the benefit, which an employee will receive after retirement. The employer has to fulfil his responsibility to compensate the employee with sufficient assets on retirement.

In the defined contribution scheme, an employer defines and funds an annual contribution. A certain percentage of an employee’s salary will be deposited in the hypothetical account created for each employee by the employer. The assets in this account will grow at a certain rate assured by the employer. This could be based on a 30 years Treasury bill (T-bills) interest rate. If this index of changes, the annual rate of return will also change.

Cash-Balance pension plan

A new pension plan scheme called cash-balance pension plan is a hybrid plan. Technically and legally, the cash-balance pension plan is like the defined benefit scheme. This plan provides benefits under predetermined formula. Structurally, however, it is quite akin to the defined-contribution scheme. The new plan has to set up a hypothetical account for each individual employee, and remit a percentage of employee’s salary fixed by the benefit formula to the account.

Advantages

The cash balance plan has several advantages, which are:

• Facilitates employees know their benefits and growth from account statements which are sent regularly
• Cost less because the employer need not keep record after employee leaves the organisation
• Simpler distribution processes since cash-balance plans offer lump-sum option to retiring employees
• Flexibility in funding, since the employer can vary contributions according to the organisation’s cash flow levels each year
• Allows investment in higher-yielding instruments to earn more than the promised rate
• Offers early accruals of benefits and portability which attract young and upwardly mobile employees

Real life problems

Long-term employees may oppose cash-balance plan, as they would get more benefit if the company follow the traditional method. For example, IBM had to face hostile response from employees when they opted for cash-balance pension plan in 1999. An organisation has to take cautious steps planning and implementing the plan, which are as follows: 

• Have transparency and communicate clearly to employees
• Based on the demographic factors like age, and years of service, organisation can give option to long-term employees to stick to traditional plan
• Utilise the savings under this plan in other investments scheme with high yield and tax savings to retain talented employees
• Give prior notice to employees along with the early retirement scheme to employees who will be affected badly

Conclusion

However, potentiality in reducing costs, and others favour cash-balance pension scheme because of its many advantages.

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