A cash balance pension plan is a defined benefit plan. Which means the benefit amount is defined or promised benefit of a stated account balance. Typically, a participant is credited each year with a pay credit, which is a percentage of pay from the employer, as well as with an interest credit that is either fixed or variable. Fluctuations of the plan’s value do not directly affect the promised benefit amounts. The employer takes on this risk.
When a participant receives benefits from a cash balance plan, they receive an account balance and have the option to take the benefit in payouts over time or in a lump-sum payment. If a lump sum distribution is taken, a rollover may be possible. Traditional defined benefit plans define the employees’ monthly benefit for life to begin at retirement, cash balance plans define the employees benefit based on a stated account balance, referred to as hypothetical accounts, because they don’t reflect contributions, gains, or losses.
The investments of a cash balance plan are managed by the employer or an investment manager that is selected by the employer. The risk is all taken by the employer. Whatever is promised to the employees is not affected by gains or losses. This is the employer’s responsibility. Unlike defined contribution plans like a 401(k), that are not insured by the Pension Benefit Guaranty Corporation, cash balance plans typically are. This means that if for any reason the pension that you were promised terminated with insufficient funds, the PBGC can become trustee and pay the benefit amounts up to the limits that are set by law.
Contributions to cash balance plans are dependent on the age of the employee. The older you are, the more you can contribute because the older you are the less time you have to save for retirement. Contributions are subject to IRS limits, but the formula is specified in the plan document. Contributions are only made by the employer.
Many employees like that cash balance plans can be offered with other retirement plans, such as 401(k)’s and many employers like that the contributions made typically reduce ordinary income on a dollar-for-dollar basis.
While a cash balance plan may be great for your business, today we just skimmed the surface. It’s best to do research and speak to a professional to see if a cash balance pension plan is right for you and your company.