One reason a company might provide a defined-benefit plan is to encourage employees to stay with the company over the long term. In most cases, it is easier to retain a good employee than to hire and train a new employee. Providing a good retirement program is an important means by which companies retain good employees. Table 3 shows the payouts of a pension plan based on the amount of time an employee has stayed with a company; the payout is shown for two different salary levels.

Table 3. Payouts Based on Time and Salary

Cash-Balance Plans

A cash-balance plan is a type of defined-benefit plan that credits your retirement account with a certain percentage of your salary each year (usually between 4 and 7 percent) plus a predetermined rate of interest. Employees have no control over the way this money is invested. The difference between cash-balance plans and plans based on a formula is that cash-balance plans grow at a predetermined rate regardless of how much money is in the account.

There are several advantages of cash-balance plans. First, like basic defined-benefit plans, these plans are noncontributory, which means that, as the employee, you do not contribute funds to this plan. Funds contributed to a cash-balance plan are free money. Second, the rate of return on a cash-balance plan is constant and guaranteed. Third, your retirement benefits are much easier to calculate because you know all of the variables and the guaranteed rate of return. Fourth, cash-balance plans are portable. If you are fully vested, you can take your principal and earnings with you when you move to another company. Fifth, cash-balance plans are much cheaper for the company, because the percentage of your salary and the guaranteed rate of return are generally low; funding these plans is not as much of a financial burden or risk to the company. One major disadvantage to employees is that the actual payouts are generally lower than the payouts of basic defined-benefit plans.