A lot of working individuals do not entirely understand what happens when a company they work for converts to a cash balance plan while other recently hired professionals often feel confused as to what cash balance plan entails as part of their benefits package. What is it and is it for your best interest? If you’re one of these people, then you need to keep on reading because we will break down cash balance pension plans for you.
A team of investment professionals will do all the work for you in a cash balance pension. It’s actually very similar to a traditional pension plan. You will have no say into the investment choices and you don’t have to put in your own money to invest. Most companies typically start paying out around age 65 while others could be as early as 55.
Your total years of service and your salary over the past few years leading up to retirement will be used as a basis to determine the benefit you receive from a pension in a cash balance plan. Furthermore, an annual credit is given to your account based on your salary each year and an average of 5 percent plus a set interest rate based on your account balance is expected. Since it is similar to a pension, a statement that contains your projected monthly income based on your current account balance will be given to you by the company.
The portability feature is another key difference between a traditional pension and a cash balance plan. If you ever decide to leave your job, you won’t be able to take the money with you in a traditional pension. A payout when you reach retirement age will be given to you instead. A cash balance plan, on the other hand, allows you to take the money with you if you change your employer. A lot of people choose to roll the funds into an IRA to make sure they’re not paying tax penalties but at least it's theirs to invest how they would like.
The reason why a company elects a cash balance plan over a tradition pension is obvious - a significant amount of money will be saved. As you may already know, that 5 percent contribution by the employer is their largest cost savings. Therefore, if the employer opts into contributing to the accounts each year instead of a fixed payout based on the last couple of years of service, the employer can expect a potentially big costs savings. Now the question is, what does it mean for you?
Depending on how the company sets up the account, a longtime employee of the employee typically sees a lower payout - that is 15 percent or more. A cash balance plan offers a greater advantage for young individuals that just entered the workforce instead of a 401(k) simply because the annual contribution is usually higher than a 401(k). Not only that, managing the funds is no longer your responsibility and you can always move the money into a personal IRA if you ever decide to change companies.
There are two types of payouts you can choose from in most cash balance plans. You may receive guaranteed monthly payouts in the form of a life annuity or receive a lump sum. It better to avoid purchasing an annuity on your own since IRS rules require annuities attached to retirement plans to meet certain requirements making it a better choice.
The market conditions can be quite unpredictable and risky so choosing to take a lump sum and investing it into an IRA may cause you to lose a portion of your account balance.
Experts say that it’s not smart to depend solely on your cash balance plan. It’s highly possible that you will need an additional source of income in the form of an IRA or 401(k) if you want to have a comfortable retirement. On that note, taking the lump sum and investing it again once you reach retirement age could be the best thing to do although consulting a financial planner is still highly recommended.
The possibility of you getting a chance to choose between a 401(k) and a cash balance plan may be low but there are companies that do offer a 401(k) along with a cash-balance plan. Some of them even match a percentage of your 401(k) contributions on top of your cash-balance plan. The bottom line is, stay in your company for a long time if it offers a benefits package that’s of great advantage to you.
