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Posted by Pat Raskob

What Is a Cash Balance Plan?

What Is a Cash Balance Plan?

This is a subset of a defined benefit pension plan. The employer often funds it via contributions made to a specific account comprising the compensation and interest of the participating employee. Usually, there is always a solid guarantee of the employee's benefit, while the employer is leaning more on the risk end depending on the fact that planned investment returns will be adequate in funding those benefits. Any losses or gains significantly influence the funding responsibility of the investor in the plan's investment portfolio. Therefore, employers must provide funds that will grow into the actual current value of the benefits distributed.

How does it work?

For an ideal cash balance plan, the participating employee's account is credited yearly with a fee credit (like a 5-10% compensation from the boss) and an additional credit (which can be a fixed or changeable) rate that is linked to an index like the one-year treasury bill value. A rise or fall in the worth of the investment plans does not directly impact the entitlements that belong to the participating employee. As stated earlier, the employer shoulders the risk of the investment.

Elevation and descending of the value of the plan's investments have no direct impact on the entitlements that are due to the candidates. Therefore, the employer shoulders the investment risks alone.

Employers can either take a massive amount of the money during retirement or choose a yearly payment option that pays over a long period. For example, if an employee has a balance of $100,000 at the retirement age of 65, they can decide to take the whole money or break it down into monthly or yearly payments. If the participating employee takes a lump-sum distribution, the distribution can be rolled over into another employer's plan if the program permits it.

The cash balance plan has pros and cons, too, like every other entity.

This type of plan is quite beneficial to organizations because it provides options for a high rate of tax reductions, the employer's ability to manage benefits that will favor employees adequately, more significant contribution limits, and more consistency in cost schedule.

Also, federal insurance protects the cash balance within certain limits through the pension benefit Guaranty corporation.

However, the cash balance plan can cause significant drawbacks for employers, in instances where short-service and young employees who haven't been part of the plan for an extended period get larger benefits and the increased rate to employers to maintain a cash balance plan. Also, the process involved in conversion can be very complex, and sometimes some participants can receive more benefits than others.

The major disadvantage for employees is the minimal benefits they receive at the early stage of their career. The employee's salary majorly determines benefits over the extended stay in the company.

Who can get a cash balance plan? Who is eligible? are there specific candidates?

Ideal candidates for the cash balance plan are employers who want to benefit more from contributions than what is allowed under conventional methods. Also, those who have the funds to make such contributions and have a mixture of the elderly and young professionals in their organization are eligible for such a plan. 

The cash balance plan offers countless business owners an exceptional retirement savings option. But it is best to understand the program to know if it is within the capacity of your company.



Pat Raskob
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