We all know the importance of setting up a retirement plan and making regular contributions to it. What you might not know much about, though, are all of the different types of retirement plans out there. Cash balance plans are becoming increasingly popular among workers across the country. Continue reading to learn what they are and how a cash balance plan works.
What is a cash balance plan?
A cash balance plan is a type of defined-benefit pension plan that defines the promised benefit in terms of a stated account balance. Each plan participant has an account that grows annually via a contribution and an interest credit. The interest credit is guaranteed rather than being dependent on the plan’s investment performance.
How does a cash balance plan work?
As mentioned above, cash balance plans grow in two ways: contribution and interest credit. The company contribution is a percentage or flat dollar amount determined by a formula in the plan. The annual interest credit is independent of the investment performance. Although it changes every year, the rate is usually equal to 30-year Treasury bonds, which are around 5 percent. When a participant retires, they’re eligible to receive the vested portion of their account balance.
How do these plans differ from traditional pension plans?
The biggest difference between cash balance plans and traditional pension plans is that cash balance plans define the benefit as a stated account balance instead of a series of monthly payments beginning at retirement. Cash balance accounts are often called “hypothetical accounts” because they don’t reflect actual contributions or actual gains and losses in the account.
How do they differ from 401(k) plans?
There are four major differences between a 401(k) and a cash balance plan. Unlike a 401(k), participation in a cash balance plan doesn’t depend on a worker’s contribution. Employers take on the risks of a cash balance plan, while employees bear the risks and rewards of their investment choices with a 401(k). Cash balance plans allow employees the ability to receive their benefits as lifetime annuities. And finally, benefits in cash balance plans are insured by the Pension Benefit Guaranty Corporation (PBGC).
Is there a law governing these plans?
Just like how a federal agency insures cash balance plans, there are federal laws that govern the plans. The Internal Revenue Code (IRC), Employee Retirement Income Security Act (ERISA) and the Age Discrimination in Employment Act (ADEA) all provide private sector pension plan protection.
Any employer found to be breaking laws related to cash balance plans must answer to the IRS, U.S. Department of Labor or the Equal Employment Opportunity Commission. It’s crucial that employers adhere to cash balance plan laws.
Is a cash balance plan right for you?
Knowing what a cash balance plan is and how it works are just the first steps. Next, you’ll need to talk to our team at Fiduciary Advisors, Ltd. We’re happy to help answer any questions you have about cash balance plans and help set up a plan for you.