Cash Balance Plan Investing: Can Buffered ETFs Improve Outcomes?
Cash balance plans have become increasingly important for business owners and professionals who want higher pre-tax retirement savings. Unlike a 401(k), a cash balance retirement plan is a defined benefit plan, meaning contributions are based on actuarial calculations, and participants are promised a set formula of benefits. Benefits are made up of pay credits and interest credits. Pay credits are determined by the plan sponsor, while interest credits are typically applied as a set percentage or a variable rate within a range (for example a flat 5%, or variable not less than zero, but not more than 6%).
The challenge in cash balance plan investing is finding the right mix of growth and protection. Too much risk exposure can create volatility and funding surprises. Too little return can cause the plan to struggle to meet crediting obligations, especially in a low interest rate environment.
Buffered ETFs are emerging as a compelling tool to balance these competing needs.
What Are Buffered ETFs?
Buffered ETFs—also called defined outcome ETFs—are structured funds designed to provide stock market participation with built-in downside protection. Below is an example of what a buffered ETF may look like:
- Mirrors the S&P 500 index over a 12-month period, with
- upside participation up to a cap (e.g., 12% ).
- downside protection up to a buffer (e.g., shielding the first 15% of losses), and
- the investment carries a 0.75% expense ratio.
The fund company uses options strategies inside the ETF to provide a more predictable return profile than traditional equity ETFs, while still maintaining liquidity and transparency. This makes them uniquely suited for cash balance plan investment strategies.
Buffered ETF Example:
Here’s a practical example of how a buffered ETF might work in a cash balance plan portfolio:
- A cash balance plan is targeting a 5% interest credit, net of fees.
- The underlying funds are invested in a Buffered ETF that mirrors the S&P 500 index with a 12% cap & 15% downside buffer over a 12-month period ending December 31.
- How It Works:
- If the S&P 500 gains 12% or less, the ETF captures that gain.
- If the S&P 500 gains 17%, the ETF returns would be capped at 12%.
- If the index drops less than 15%, the ETF sidesteps the loss, keeping performance at zero.
- If the index falls 20%, the first 15% will be buffered resulting in a 5% loss for the fund.
Keep in mind that if the expense ratio in this example is 0.75%, performance will be reduced by that amount. So, a capped return of 12% would net closer to 11.25% after fees.
The rolling maturity of these funds align neatly with how most cash balance plans credit interest—typically on a calendar or plan year basis—making it easier for sponsors to match assets with liabilities.
Historical Perspective: How Often Has the S&P 500 Lost More Than 15%?
In the last 50 years, the S&P 500 has dropped more than 15% in a calendar year only five times:
- 1973: –17.4%
- 1974: –29.7%
- 2002: –23.4%
- 2008: –38.5%
- 2022: –19.4%
This history shows that while significant drawdowns do happen, they are relatively rare. A 15% downside buffer would have eliminated losses in many challenging years, smoothing out results for plan sponsors and making cash balance plan investing more predictable.
Asset Allocation in Cash Balance Plan Investing
Traditional cash balance retirement plans lean heavily on fixed income for stability. But in a low interest rate environment, bond yields often fall short of the plan’s crediting rate. That mismatch creates pressure on funding.
Buffered ETFs give plan sponsors another tool:
- Growth Potential: Higher expected returns than bonds.
- Risk Management: Reduced volatility compared to traditional equities.
- Flexibility: ETFs are daily liquid. There are no lockups or liquidity windows.
- Timing Alignment: ETF maturity dates can be aligned with the plan-year to define the portfolio outcomes.
The Bottom Line: Buffered ETFs in Cash Balance Plan Investing
Cash balance plan investing requires a disciplined approach. Buffered ETFs offer a middle ground—providing downside protection, predictable resets, and growth potential that aligns with plan crediting schedules. Incorporating buffered ETFs into a cash balance investment strategy can mean smoother funding, reduced volatility, and may be a smart way to pursue growth while protecting the plan’s obligations.