A cash balance plan refers to a specific type of pension plan. Depending on where you work, it may be part of the benefits package your company currently offers. It is also possible for the company to switch to a cash balance plan from another type of pension plan. If you are applying for work at a new company, you may also be eligible for a cash balance plan.
It is important for you to understand what a cash balance plan is and how it may affect you.
Standard pension plans come in two types. These are defined contribution plans and defined benefit plans. A cash balance plan is somewhat of a cross between the two. It is technically categorized as a defined benefit plan. The cash balance plan allows you to receive a lump sum payment of your plan balance upon retirement or collect ongoing annuity payments. The following information can help you understand the details of how a cash balance plan works and whether it is beneficial for your retirement plan.
How a Cash Balance Plan Works
A cash balance plan allows you to collect two types of annual payments. Your employer puts payments into the cash balance plan fund based on a percentage of your annual earnings. An additional interest credit is also deposited into the fund. The amount of credit may be based on a variable rate. However, a fixed interest payment is also possible. The exact amount added to the cash balance plan each year is based on several variables, including:
- The number of years you work for the company.
- Your annual salary prior to retirement.
- Your total account balance.
- The salary you collect each year you work for the company.
A cash balance plan offers you some degree of security because it is federally backed. The Pension Benefit Guaranty Corporation provides insurance on such a plan. However, there are some limitations on the government insurance offered due to federal laws. It is important to familiarize yourself with the exact amount of protection offered for your specific plan.
Cash Balance Plans Versus Standard Defined Benefit Pension Plans
A standard defined benefit pension plan is designed to provide the most benefit to you if you work for a single company for many years. This is because the amount of money you receive through such a plan is based on how long you work for the company in question. It is also based on the salary you earn when you near retirement. Since you are more likely to have a high salary when you stay with a company for many years, you receive additional benefits for your company loyalty.
The funds you receive from a cash balance plan are not based on your number of years working for one company. You may receive the same benefit for the year as a co-worker who has worked at the company for a completely different length of time. The benefits you receive for a cash balance plan are also more likely to grow at a steady pace.
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Another significant difference between a defined benefit pension plan and a cash balance plan is in the ability to move the funds if you change jobs. This ability is non-existent when you have a defined benefit pension plan. If you begin working at a new company, any funds deposited in the pension plan stay with the old company. The funds are released to you when you reach a set retirement age. In contrast, a cash balance plan allows you to move any funds in your account to another account when changing jobs. Some tax penalties for doing so may apply, but you can avoid those penalties by placing the funds in your IRA account, if you have one.
Cash Balance Plans Versus Defined Contribution Pension Plans
A defined contribution pension plan is a plan with a specific amount of contributions from your employer. This amount is clearly outlined from the beginning. In some cases, you may also contribute funds to a defined contribution pension plan. The most well-known example of such a plan is a 401(k). A cash balance plan differs from a 401(k) in the following ways:
- You can opt to deposit funds in a 401(k), but you have no such option with a cash balance plan.
- When you have a cash balance plan, your employer or a representative of your employer can use the funds to make investments over which you have no control. However, you also do not lose funds when poor investments are made. Your employer loses funds, instead.
- If you have a 401(k), you may make investments into the fund and receive rewards from good investments, but you must also accept responsibility for losses from poor investment results.
- A cash balance plan must offer you the option of receiving lifetime annuity payments. No such option is required with a 401(k) plan.
- The Pension Benefit Guaranty Corporation insures a cash balance plan, but it does not insure any type of defined contribution pension plan, including a 401(k).
Benefits of a Cash Balance Plan for You and Your Employer
You have no control over whether your employer offers a cash balance plan as part of your benefits program or another pension plan. However, if a cash balance plan is offered, it can benefit you and your employer in several ways. Potential benefits to you may include the following:
- You can take funds with you, if you change jobs.
- There is no great loss of benefits when changing jobs because a cash balance plan does not reward longevity at one place of employment the same way another type of pension plan does.
- You can choose from a lump sum payout or ongoing annuity payments when it is time to collect your cash balance plan funds.
Today’s employment market is rife with short-term job opportunities. You may be unlikely to work for a single company until you retire. When you apply for a job, your potential employer may realize you are unlikely to stay permanently and have a cash balance plan in place to entice you to accept a temporary position. Offering a cash balance plan instead of another pension plan type may also save the employer money in the long run due to the differences in the payout systems. Additionally, a cash balance plan is less complex, making it easier for your employer to manage and explain to you and any other employees receiving cash balance plan benefits.
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