What Is a Cash Balance Pension Plan?
The term cash balance pension plan refers to a defined-benefit pension plan with the option of a lifetime annuity. For a cash balance plan, the employer credits a participant's account with a set percentage of their yearly compensation plus interest charges. 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.
- A cash balance pension plan is one in which participants receive a set percentage of their yearly compensation plus interest charges.
- This type of plan is maintained on an individual account basis, much like a defined-contribution plan.
- The benefit of such plans is that contribution limits increase with age.
- People 60 years and older can save well over $200,000 annually in pretax contributions compared.
- When combined with a 401(k), contributions usually amount to roughly 6.9% of pay compared with the 4.7% contributions that are typical of 401(k) plans only.
Understanding Cash Balance Pension Plans
A cash balance plan is maintained on an individual account basis, much like a defined-contribution plan. This means it isn't like the regular defined-benefit plan. The cash balance plan acts just like a defined-contribution plan because changes in the value of the participant's portfolio do not affect the yearly contribution.
The features of cash balance pension plans resemble those of 401(k) plans. Investments are managed professionally, and participants are promised a certain benefit at retirement. However, the benefits are stated in terms of a 401(k)-style account balance rather than the terms of a monthly income stream.
Having a cash balance and a 401(k) pension plan can help individuals slash their tax bills and bolster their nest egg. Those who depend on generous traditional pension plans are less enthusiastic. Many older business owners seek out these types of plans to turbocharge their retirement savings because of the generous contribution limits that increase with age.
People 60 years and older can sock away well over $200,000 annually in pretax contributions. Combined 401(k) employer-employee contributions for those 50 and older are much more limited. The maximum combined contribution for 2022 is $67,500, which is an increase from the $64,500 limit in 2021. This figure includes a $6,500 catch-up allowance for those aged 50 and over.
The benefits of individuals who participate in private-sector pension plans are protected by various federal laws, such as the Employee Retirement Income Security Act (ERISA).
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 4.7% 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 30-year Treasury rate. At retirement, participants can take an annuity based on their account balance, or a lump sum, which can then be rolled into an IRA or another employer's plan.
But there is a downside. Cash balance pension plans are often more expensive than traditional employer-sponsored 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 management fees.