On the surface, the battle of pension plans was won by defined contribution (DC) plans long ago. But now, defined benefit plans are making a comeback at some small companies.

It is a particularly unlikely turn of events, since by the early 1980s defined benefit (DB) plans, known more simply as pension plans, had already been in a long decline. Long the retirement vehicle for large companies, these plans began to face troubles as they underperformed, thanks to stagnant equity markets starting in the late 1960s, and, worse, as the companies that provided them began to go bankrupt. Under DB plans, a company guarantees the amount of monthly payments retirees receive for the remainder of their lives.

Enter the 401(k) defined contribution plan. While often seen as less financially rewarding or secure to employees, this plan does have two benefits over the traditional DB plan: It gets the company off the hook for the pension fund's performance and gives responsibility back to the employee to manage his or her own retirement assets. DC plans are so named because they were based on regularly defined contributions by the employee and/or the company to the retirement plan. How it performs is not the company's concern. It's up to the retiree to manage his own retirement assets and make sure he has enough when he's finished working.

Today, less than 25% of the country's private working population have DB plans. But despite that decline, retirees still debate which plans are better. That has thrown the spotlight on public employee pension plans, including Social Security, which are essentially taxpayer-financed DB plans.

Those who recommend DC plans for small businesses-usually in the form of 401(k) plans-can point to some 30 years of market growth. Business owners and their planners can find plenty of cheap and efficient off-the-shelf plans geared to small businesses-plans that can take care of most administrative, actuarial and funding mechanisms.

Despite the seemingly universal success of 401(k) plans, they do have their drawbacks. Indeed, hardly a week goes by that a large mutual fund or insurance company doesn't release a survey detailing how workers are not saving enough to fund their own retirements.

This has led to new small-form or hybrid DB plans, especially the cash balance plan (CBP), designed for the small employer. On a purely numerical basis, the growth rate in CBPs is far outstripping that of 401(k) plans. Yet such numbers must be taken with a grain of salt. As Michael Prendergast, CFP and managing advisor with New York-based Altfest Personal Wealth Management, puts it, most small business owners have never even heard of CBPs. Their extraordinary growth is almost entirely due to the low base they are starting from.

The great benefit to any company with a DC plan is that it is never on the hook to provide retirees with an agreed upon benefit for the rest of their lives-no matter what exigencies, catastrophes (or successes) the company may subsequently go through. DC plans are by definition always "fully funded" (though to the great chagrin of some employees, say those at Enron whose plans were stuffed with company stock, this funding can itself prove to be a chimera).

Congress first acted in 1985 to stop the slide of DB plans and reinvigorate them-through a new channel-into small businesses. Unfortunately, the legislation had legal and financial holes in it and did not have the intended effect. They did not begin to be more widely adopted until the Pension Protection Act of 2006 helped clarify the concerns of business owners, according to Kravitz Inc., an Encino, Calif.-based administrator and manager of retirement plans.

Still, even that fix left problems that were not finally addressed until last November and further clarified by court rulings this spring. But as Prendergast of Altfest Wealth Management notes, many small companies remain ignorant of their potential benefits.

As a fee-only advisory firm with $700 million in assets under management, Altfest has no inherent stake in whether a client chooses a CBP or a traditional DC retirement plan. Prendergast is up front in describing both the benefits and drawbacks to the plans. With a wide variety of clientele, Prendergast admits the choice is not to be taken lightly. It can involve a more focused and costly approach, including having administrators and actuaries do financial forecasting as well as examinations of a company's cash flow, long-term financial prospects, employee demographics, the age of employees and the hiring of future employees, which could affect the plan. In general, companies should have strong cash flow and strong long-term prospects before considering a CBP, he notes.

But the overriding benefit is that a CBP can favor a business owner's own retirement planning. A properly set up plan allows for much greater annual contributions than a 401(k) or a related profit-sharing retirement plan. It allows for, say, a 50-year-old middle-aged entrepreneur to make dramatic increases in his retirement funding-funding he may have failed to make at an earlier age.

And the CBP needn't be an either/or proposition, Prendergast says. "These plans can be set up in conjunction with other plans." So not only can business owners help bring their own retirement plans up to speed, they can pass the CBP along as a benefit to their employees.

Make no mistake, though. CBPs are qualified retirement plans (which is what gives them their tax-deferred status and allows them to accumulate assets rapidly). That means they must meet certain IRS requirements for performance, payout and employee inclusion-all of which can leave employers on the hook if the plans underperform. This problem was largely responsible in the past for the failure of corporate DB plans and it is why some advisors tell businesses to stay away from them.

Leonard Witman, an attorney with Witman Stadtmauer of Florham Park, N.J., which specializes in employee benefits, has worked for years with 401(k)s and CBPs. His advice: Stay away from CBPs. The risks far outweigh the benefits.
Although Congress and the IRS changed the regulations for CBPs in 2006 and again last year in an attempt to make the plans more user-friendly, Witman says they can still be nightmares. "Some are wonderful, but some haven't turned out so well," he says.

Though CBPs are qualified plans, he emphasizes they are "not socially conscious plans. They're basically for the employer who wants to provide for his family." And an employer can often simply do this with a 401(k) plan, without needing a CBP.

Witman sees several problems with CBPs. First, they require a higher level of maintenance and oversight than a typical off-the-shelf 401(k), many of which are run by large, reputable organizations that take most of the headaches-be they legal, financial or administrative-off the table for the business owner.

Another problem is that while a CBP might be set up initially to work seamlessly, it needs to be watched each and every year as a company's employee demographics change. "You'd better have a really good third-party administrator and actuary working along with the plans. What can happen is it can really get screwed up as things change."

Another problem occurs because it's a fixed obligation to provide a benefit." By way of example, Witman notes that a number of CBPs were invested with Bernard Madoff and the employers are now on the hook for the amount stolen-despite the fact that they were cheated just like their employees.

There is also a potential problem with a CBP over-performing. That's because employees see how well the plan is doing over time and then are unhappy to discover that none of that overperformance accrues to them. Plenty of employers have been sued by unhappy retirees, Witman says.

While the government helped clarify an employer's legal obligations over this at the end of 2010, Witman says it won't stop the lawsuits. "Unlike a 401(k) or a defined contribution plan, when you run it properly you're going to be OK." Not so with a CBP. "You better have a really good actuary who periodically adjusts the plan," he says. "Being a lawyer, I see the problems as they ensue. Your investments are more subject to scrutiny."

That sentiment goes a long way toward explaining the lack of awareness among the universe of small business users. But is it that simple? In these uncertain times, everyone wants stable income over the long haul. CBPs offer that. So they do have their cheerleaders.

A paper this past spring asked, "Is It Time to Reconsider Cash Balance Plans?" It said new IRS rules mitigate the risk for companies by allowing account values to increase only year by year. "Essentially, cash balance plans act like stable-value funds, providing a dependable floor of protection." They can save as much as 2% of payroll each year. While there is no guarantee, it may be a risk worth taking.

One strong supporter of CBPs is Kravitz Inc., an Encino, Calif.-based administrator and manager of retirement plans. Using IRS numbers from 2009, Kravitz found that the growth rates of CBPs significantly outpaced those of 401(k)s. From 2001 to 2009, the number of CBPs grew about 20% annually versus 3% for 401(k)s. By 2008, it said, CBPs made up 11% of all DB plans, and the firm predicted the number would jump to 15% for 2010 after all filings were assessed.

Kravitz said that 82% of companies with CBPs have fewer than 100 employees. (Medical and dental groups, incidentally, accounted for 37% of all CBPs nationally.) Such companies are a prime constituency for planning firms working with small businesses.

Kravitz points to other benefits of CBPs over traditional DB plans: With individual account balances, they're easier to understand; they remove the interest rate risk that leads to constantly changing values of liabilities; and they allow for more consistent contributions to employees, rather than uneven age-based contributions.

Because of eloquent spokesmen such as Prendergast and Kravitz, it may not be long before small businesses and the planners who serve them become more familiar with CBPs.

Robert Laura is president of SYNERGOS Financial Group, author of Naked Retirement (http://www.nakedretirement.com) and co-founder of RetirementProject.org. Laura can be reached at 888-267-1138.