Hybrid retirement plans have been gaining in popularity over the last decade or so. Many third party administrators find themselves designing more plans today then they ever dreamed of. But the question still remains – what is a hybrid retirement plan?
Before we try to understand what hybrid plans are, we need to understand the difference between defined contribution plans and defined benefit plans.
When most people think of retirement plans they think of defined contribution plans. This would be your typical 401k plan. It is “defined” by how much you can contribute. In addition, it defines how much your employer is going to contribute. There is no guaranteed rate of return or discussion about how much your account balance will be at a certain point in time.
Employees are able to contribute a certain amount and may increase or decrease those contributions as they see fit. Assumptions can be made based on interest rates, compounded growth and age about how much will be in the account at a certain date. But there is no guarantee. This is an important distinction as we compare it to a defined benefit plan.
When people think of 401k plans they are thinking of defined contribution plans. However, when people think of social security they are thinking of a defined benefit plan. There isn’t much discussion about how much your employer is contributing. This discussion surrounds what the payments will be at a speficied retirement date or what lump sum is available. The ending “benefit” is what is important.
Hybrid plans contain similarities of both defined benefit plans and defined contribution plans. This enables a company and it’s employees to benefit from features of both types of plans.
One important reason for the growth of hybrid is the ease of understanding participant’s retirement benefit.
The cash balance plan is the most popular (and some would say best) hybrid plan.
Another benefit was the rotation to retirement income based using lump sum values, just like a 401(k) plan, and the usage of lump sum payment options. In recent years, small employers have established cash balance plans because they provide higher retirement income than traditional defined contribution plans.
With the improved employee understanding of hybrid plans, there is no reason to believe they will be going away anytime soon.