What Is a Cash Balance Pension Plan?

A cash balance pension plan is a defined-benefit pension plan with the option of a lifetime annuity. The employer credits a participant's account with a set percentage of their yearly compensation plus interest charges for a cash balance plan. The funding limits, funding requirements, and investment risk are based on defined-benefit requirements. Changes in the portfolio do not affect the final benefits received by the participant upon retirement or termination, and the company bears all ownership of profits and losses in the portfolio.

Understanding Cash Balance Pension Plans

A cash balance plan (CBP) is maintained on an individual account basis, much like a 澳洲幸运5官方开奖结果体彩网:defined-contribution plan. The features of cash balance pension plans resemble those of 401(k) plans. Investments are managed professionally, and participants are promised a specific benefit at retirement. However, the 澳洲幸运5官方开奖结果体彩网:benefits are stated in terms of a 401(k)-style account balance rather than the terms of a monthly income stream.

For instance, an employee on a cash balance pension plan might receive a promise of 5% of their salary with a 5% interest credit. If they made $100,000 annually, they would receive a pay credit of $5,000 plus 5% interest paid on the account balance. As the number of years at the employer increases, the account balance grows to meet the balance promised by the company. At retirement, the employee can choose a 澳洲幸运5官方开奖结果体彩网:lump-sum payment or a monthly annuity payment.

Cash Balance Pension Plan vs. Traditional Pe🌄nsion Plan

The most significant difference between a cash balance pension and a traditional pension plan is that the traditional plan generally uses a few years of your highest compensation to de🎉termine your monthly benefit. A cash benefit pension plan uses the total number of years you've been with the company.

Cash Balance Pension Plan vs. 401(k)

The most significant difference between a cash balance pension and a 401(k) is that the employer bears the investment risk in a CBP. The employer is responsible for ensuring the employee receives the amount promised, so no matter what happens, it must ensure the employee gets that amount. With a 401(k), the employee bears the investment risk because they choose the way the plan invests. The employer has no investment risk. Additionally, the retirement benefit amount depends on the balance of the account; it isn't guaranteed, as it is with a cash balance pension.

The other difference is the 澳洲幸运5官方开奖结果体彩网:contribution limit. People 60 years or older can sock away well over $300,000 annually in 澳洲幸运5官方开奖结果体彩网:pretax contributions.

Pros and Cons of a Cash Balance Pension Plan

While thi𓂃s type of plan does have several benefits, there ar𒅌e some disadvantages to consider, as well.

Pros Explained

• Lump Sum Payouts: A cash balance pension' payout can be as a lump sum. This can benefit someone who wants to place the capital in a traditional preservation instrument like government bonds or 澳洲幸运5官方开奖结果体彩网:money market funds.
• Rollover Options: You can roll a lump sum payout into an IRA or another pension plan.
• Tax-Deferred: Contributions are 澳洲幸运5官方开奖结果体彩网:tax-deferred. This means you don't pay taxes on the funds until you make withdrawals 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. 澳洲幸运5官方开奖结果体彩网:Individu🐽al retirement accounts (IRAs) and 401(k)s have annual limits set by the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS).
  

Cons Explained

• Taxable Distributions: While the tax-deferred treatment is a benefit, you will have to 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.
• No Employee Contributions: Only the employer contributes, so you can't add capital from your wages.
  

Special Considerations

When combined with a 401(k) plan, cash balance employer contributions for rank-and-file employees usually amount to roughly 6.9% of pay compared with the 4.6% contributions that are typical of 401(k) plans only.

Participants receive an annual interest credit. This credit may be set at a fixed rate, such as 5%, or a variable rate, such as the 澳洲幸运5官方开奖结果体彩网:30-year Treasury rate. At retirement, participants can take an annuity based on their account balance or a lump sum, which can then be 澳洲幸运5官方开奖结果体彩网:rolled into an IRA or another employer's plan.

Cash balance pension plans are often more expensive to administer than traditional employer-sponsored 澳洲幸运5官方开奖结果体彩网:retirement savings plans like the 401(k). That's because these pension plans require certification to ensure they're adequately funded. The types of fees and amounts for each can vary, but cash plans tend to have higher startup costs, annual administration charges, and relatively high 澳洲幸运5官方开奖结果体彩网:management fees.

The Bottom Line

A cash balance pension plan is similar to other retirement accounts. The contributions are tax-deferred for the employee, and the principal grows with 澳洲幸运5官方开奖结果体彩网:compounding interest and capital gains. The emplo𝄹yer takes on all of the investment risk. The employee can use their wages to invest i💯n another retirement fund of their choice.

While a cash balance pen♔sion is an excellent retirement plan option, you should choose one with caution. Compare the tax treatment you expect to receive when you retire to see if it or another plan would work better for your financial situation.