Cash Balance Pension Plan: Overview, Pros and Cons
What Is a Cash Balance Pension Plan?
9A defined-benefit pension plan with the option of a lifetime annuity is known as a cash balance pension plan. For a cash balance plan, the employer credits a participant’s account with a predetermined percentage of their annual salary plus interest. Defined-benefit requirements serve as the foundation for the funding restrictions, specifications, and investment risk. The corporation owns all of the portfolio’s gains and losses, and changes to the portfolio have no bearing on the participant’s final benefits upon retirement or termination.++[[[+
Understanding Cash Balance Pension Plans
A cash balance plan (CBP), like a defined contribution plan, is managed on an individual account basis. Cash balance pension programs have characteristics with 401(k) plans. Participants are guaranteed a certain benefit upon retirement, and investments are professionally managed. In contrast, the benefits are expressed in terms of a monthly income stream rather than a 401(k)-style account balance.1.
For example, a cash balance pension plan may give a worker 5% of their pay with a 5% interest credit. A pay credit of $5,000 plus 5% interest paid on the account amount would be given to them if their yearly income was $100,000. The account balance rises as the number of years spent with the employer increases to meet the balance that the business promised. At retirement, the worker has the option of receiving a lump sum payment or a monthly annuity.
Cash Balance Pension Plan vs. Traditional Pension Plan
The main distinction between a cash balance pension and a traditional pension plan is that the former often calculates your monthly payout by taking a few years of your peak income. The total number of years you have worked for the company is used in a cash benefit pension plan.
Cash Balance Pension Plan vs. 401(k)
The primary distinction between a cash balance pension and a 401(k) is that under a CBP, the employer assumes the investment risk. In any case, the employer must make sure the employee receives the promised amount because it is their responsibility to do so. Because the employee chooses how the plan invests, they are responsible for the investment risk in a 401(k). There is no risk to the employer’s investments. The retirement benefit amount is also contingent on the balance of the account and is not guaranteed, unlike a cash balance pension.
Pros and Cons of a Cash Balance Pension Plan
While this type of plan has several benefits, there are some disadvantages to consider.
Pros:
- Lump sum payouts
- Rollover options
- Tax-deferred
- Custom contribution limit
Cons:
- Taxable distributions
- High cost to maintain
- No employee contributions
Pros Explained
- Lump Sum Payouts: A cash balance pension payout can be a lump sum. This can benefit someone who wants to place the capital in a traditional preservation instrument like government bonds or money market funds.
- Rollover Options: You can roll a lump sum payout into an IRA or another pension plan.
- Tax-Deferred: Contributions are tax-deferred. This means you don’t pay taxes on the funds until you withdraw or take a lump sum payment. If you’re in a higher tax bracket when you’re contributing than when you make withdrawals, you pay less in income tax.
- Custom Contribution Limit: The annual limit for a cash balance pension depends on how much you make, how old you are, and the target date and balance of the fund to IRAs and 401(k)s have annual limits set by the IRS.
Cons Explained
- Taxable Distributions: While the tax-deferred treatment is a benefit, you must pay taxes when you withdraw money.
- High Costs to Maintain: The costs to maintain the plans are higher because an actuary is needed to ensure it performs well enough to meet the balance requirements. This translates into higher costs for employers.3
- No Employee Contributions: Only the employer contributes, so you can’t add capital from your wages.
Special Considerations
In contrast to the 4.6% contributions that are typical of 401(k) plans alone, cash balance employer contributions for rank-and-file employees often amount to approximately 6.9% of pay when paired with a 401(k) plan.56
An annual interest credit is given to participants. This credit might have a variable rate, like the 30-year Treasury rate, or a fixed rate, like 5%. When they retire, participants can choose to take a lump sum payment or an annuity based on their account balance, which they can then roll over into an IRA or another employer’s plan.
Compared to more conventional employer-sponsored retirement savings plans like the 401(k), cash balance pension programs are frequently more costly to run. To guarantee they have sufficient funding, these pension schemes must be certified. The costs and sums for each may differ.
Is a Cash Balance Pension Plan Better Than a 401(k)?
Both can make great arrangements for retirement. Your tastes, objectives, potential length of employment, and present income will all influence which option is best for you.
What Can I Do With a Cash Balance Plan?
You have the option of receiving a lump sum payment or making withdrawals. You can roll over a lump payment into an IRA or another retirement plan if you decide to take one.
What Happens to My Cash Balance Pension If I Quit?
When you leave the company, you can transfer the vested component of your cash balance pension to another retirement account since it is portable.
