A cash balance pension plan is a type of retirement plan offered by some companies. This type of plan is slightly different from the traditional pension plan. Here are the basics of the cash balance pension plan.
Cash Balance Pension Plan
There are traditionally two types of pension plans available. There are defined contribution plans and defined benefit plans. With a defined benefit plan, the employer tells the employee how much she will be able to expect to receive upon retirement. The defined contribution plan tells the employee how much the employer is contributing to her account. When the employee retires, she will be able to access the money that has been contributed with gains or losses from investing. With a cash balance pension plan, you are dealing with a plan that has characteristics of both types of pension. It is technically a defined benefit plan that is reported to the employee as if it were a defined contribution plan. You are able to see a cash balance in the plan over the years of your employment.
How They Work
With a cash balance pension plan, you will be able to look at your plan every year and see a credit that has been posted. Depending on how much the employer has promised to contribute to your pension, you will see this amount credited to your account each year. For example, they might agree to put 3 percent worth of your annual salary into the account. They will also show a credit for the interest that the money in the account would earn. For example, they might show the interest rate of a US Treasury bill.
Although these numbers are demonstrated to the employee, they are basically done for show. The money is not actually sitting there in an individual account for the employee. It is also not drawing that particular rate of interest. The actual money is invested in a variety of investments on behalf of the employer. The employer is taking all of the risk with the investments and promises to pay the employee a certain amount upon retirement. The cash balance shown is simply for the benefit of the employee.
When the employee is getting close to retirement, the benefits that will be available to her are spoken of in terms of a cash balance. For each year that she has worked, she has essentially earned a larger guaranteed payout upon retirement. For example, if her cash balance pension plan shows that she has $500,000, this is the amount that she is guaranteed to receive.
With this type of plan, the retiree can choose to take the funds as an annuity, which will provide her with a regular payment every month. However, she can also choose to take the money as a lump sum. The option to take a lump sum is not common with other types of pension plans. You are also able to take this lump sum and roll it into an IRA.