What is a Cash Balance Pension Plan?
A cash balance pension plan is a pension plan in which an employer credits a participant's account with a set percentage of his or her yearly compensation plus interest charges. A cash balance pension plan is a defined-benefit plan. As such, the plan's funding limits, funding requirements and investment risk are based on defined-benefit requirements: as changes in the portfolio do not affect the final benefits to be received by the participant upon retirement or termination, the company solely bears all ownership of profits and losses in the portfolio.
Understanding Cash Balance Pension Plans
Although the cash balance pension plan is a defined-benefit plan, unlike the regular defined-benefit plan, the cash balance plan is maintained on an individual account basis, much like a defined-contribution plan. The cash balance plan acts similarly to a defined-contribution plan also because changes in the value of the participant's portfolio does not affect the yearly contribution.
The added features of a cash balance pension plan resemble those of 401(k) plans. As in a traditional pension plan, investments are managed professionally and participants are promised a certain benefit at retirement. However, that benefit is stated as a 401(k)-style account balance, rather than in the terms of a monthly income stream.
Having a cash balance pension plan, in addition to a 401(k), can help a retirement saver slash their tax bills and bolster their nest egg. However, 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. In a 401(k), total employer and employee contributions for those 50 and older are limited to $57,500.
- A cash balance pension plan is one in which participants receive a set percentage of their yearly compensation plus interest charges.
- The benefit of such plans is that contribution limits increase with age but they only cover part of a retiree's expenses.
How Cash Balance Pension Plans Work
Cash-balance employer contributions for rank-and-file employees usually amount to roughly 5 to 8 percent of pay, compared with the 3 percent contributions that are typical of 401(k) plans. Participant accounts also receive an annual "interest credit," which may be a fixed rate, such as 5 percent, 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 then can be rolled into an IRA or another employer's plan.
Cash balance pension plans can be more costly to employers than 401(k) plans, in part because an actuary must certify each year that the plan is properly funded. Typical costs include $2,000 to $5,000 in setup fees, $2,000 to $10,000 in annual administration fees, and investment-management fees ranging from 0.25 to 1 percent of assets.