What is a Cash Balance Pension Plan?

A cash balance pension plan is a defined-benefit plan with the option of a lifetime annuity. Cash balance plans are qualified, meaning contributions are tax-deferred until retirement. The main benefit of these plans is their ability to supercharge retirement savings later in someone’s career. Cash balance pension plan contribution limits increase with age and end up far surpassing those of other retirement vehicles such as 401(k)s.

How Does a Cash Balance Pension Plan Work?

With a cash balance pension plan, employers credit a participant’s account with a percentage of their yearly compensation or a flat dollar amount, plus an interest credit. Contribution amounts are determined by a formula established at the time of the plan’s creation, and different employees can have different contribution amounts. The interest credit can be set at a flat rate, or follow a variable rate such as the 30-Year Treasury rate. The interest credit is guaranteed and not dependent on portfolio performance. As a defined-benefit plan, account balances do not shrink or grow alongside their underlying investments. This leaves the business to shoulder any investment risk, not the employee.

At retirement, plan participants can take an annuity based on their account balance, or a lump sum. The lump sum can be rolled into other plans that accept rollovers, such as an IRA or another employer’s plan. Participants are able to receive the vested portion of their account balances upon leaving their employer. Cash balance pension plans can be offered alongside other plans like a 401(k), further increasing annual retirement contribution limits.

Businesses can deduct contributions for employees who are not owners or partners. Corporations are also able to deduct contributions for owners.

Who Benefits from Cash Balance Pension Plans?

Cash balance pension plans are a preferred retirement offering to those looking to ramp-up their contributions later in life. Owners often choose to invest heavily in their business early in its life cycle instead of making retirement contributions. Cash balance plans are a great way to “catch up” due to their high contribution limits.

This type of plan comes with tradeoffs though. They can be more expensive than traditional retirement offerings due to the special certifications required to ensure they’re properly funded. When compared to other retirement vehicles, higher startup, administrative, and management fees are not uncommon. Since cash balance plans are pensions that require annual contributions from the employer, consistent cashflow and profit is important for successful implementation. These plans typically aren’t good fits for businesses with swings in revenue. The employer also bears any market risk should the plan’s investments grow at a slower than expected rate or lose value, since the contributions and benefits are predetermined. Although the plan can be amended after its creation, such options are limited in scope and come with restrictions.

The information provided is for informational purposes only.  It is not intended to be used, and should not be used, as the sole basis for legal and/or tax advice.  Individuals should seek and rely upon the guidance and advice of their own legal and tax counsel before making any decisions regarding any planning, investment, tax concepts or strategies discussed herein.  Individual circumstances may vary and results discussed are no guarantees of applicability or future performance.

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