Cash Balance Pension Plan: Overview, Pros and Cons

---

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, 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 plan (CBP) is maintained on an individual account basis, much like a 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 benefits are stated in terms of a 401(k)-style account balance rather than the terms of a monthly income stream.1

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. The employee can choose a lump sum or a monthly annuity payment at retirement.

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

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 how the plan invests. The employer has no investment risk. Additionally, the retirement benefit amount depends on the account's balance; it isn't guaranteed, as with a cash balance pension.

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

• 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.
  

• 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.
  

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.56

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.

Cash balance pension plans are often more expensive to administer than traditional employer-sponsored retirement savings plans like the 401(k). These pension plans require certification to ensure they're adequately funded. The fees and amounts for each can vary, but cash plans tend to have higher startup costs, annual administration charges, and relatively high management fees.

Both can be excellent retirement plans. Which one is better depends on your preferences, goals, how long you might be with an employer and current income.

You can choose to make withdrawals or a lump sum payout. If you choose a lump sum, you can roll it into an IRA or other retirement plan.

Your cash balance pension is portable, so you can take the vested portion with you when you part ways with the company and roll it into another retirement account.