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Cash Balance Pension Plan

Definition

A Cash Balance Pension Plan is a type of defined benefit pension plan that combines features of both traditional pension plans and defined contribution plans. In this plan, an employer credits a participant’s account with a fixed percentage of their salary and a guaranteed interest rate. Upon retirement, participants can choose to receive their cash balance as a lump sum or as annuity payments.

Phonetic

The phonetics of the keyword “Cash Balance Pension Plan” are: /kaʃ ˈbæləns ˈpɛnʃən plæn/- Cash: /kaʃ/- Balance: /ˈbæləns/- Pension: /ˈpɛnʃən/- Plan: /plæn/

Key Takeaways

  1. Cash Balance Pension Plans are a hybrid retirement plan that combines features of both defined benefit and defined contribution plans, offering some attributes of traditional pensions along with the flexibility of 401(k) plans.
  2. In a Cash Balance Pension Plan, each participant has an individual account that grows in two ways: with a percentage of their annual salary contributed by the employer (called a pay credit) and with an interest credit based on a predetermined interest rate.
  3. Upon retirement or termination of employment, participants can choose to receive their Cash Balance Pension Plan balance as a lump sum payment or as an annuity. This provides employees more flexibility and options when it comes to the distribution of their retirement benefits.

Importance

The Cash Balance Pension Plan is a crucial business/finance term as it represents a unique type of pension plan that combines features of both traditional defined benefit pension plans and defined contribution plans. It is essential because it offers employees a more predictable retirement benefit while providing employers the advantage of better contribution and cost control. In a Cash Balance Pension Plan, participant accounts receive regular credits based on a predetermined interest rate, ensuring stable growth over time. Furthermore, this plan reduces the financial risks employees face concerning market fluctuations and guarantees a specific benefit at retirement, making it an important retirement vehicle that benefits both employees and employers.

Explanation

A Cash Balance Pension Plan is a unique retirement savings vehicle designed to serve both the employer and the employee in accumulating sufficient funds for the employees’ post-employment years. The primary purpose of this type of pension plan is to provide a more predictable retirement benefit, wherein both parties share the investment risks and rewards. Employers will define an annual contribution and an interest crediting rate (often tied to a common benchmark, such as a government bond yield) which is credited to each participant’s cash balance account. As employees work through their careers, this steady accumulation of funds contributes to a stable and consistent growth of their retirement nest egg.

In addition to offering financial security for the employees, Cash Balance Pension Plans also provide a level of flexibility and portability that makes it particularly appealing in the modern workplace. Since the benefits are account-based, employees can easily transfer their balances when transitioning from one job to another or even opt for a lump sum payout upon retirement. This allows employees to tailor their retirement strategies to their individual needs and circumstances, while also reducing the long-term financial burden on employers.

Furthermore, due to its hybrid structure combining features of both defined benefit and defined contribution plans, Cash Balance Pension Plans enable employers to better manage their pension liabilities, which is vital in ensuring the long-term sustainability of the retirement system.

Examples

1. IBM Cash Balance Pension Plan: In 1999, IBM introduced its cash balance pension plan, which replaced their traditional pension plan. The new cash balance plan aimed to provide a more portable pension benefit for their workforce, offering a flexible retirement option for employees who may change jobs more frequently. This plan allowed employees to have an individual account with a specified balance based on years of service, salary, and a pre-determined interest rate. This change caused controversy as it negatively impacted many long-term employees, but it is still widely regarded as a significant example of a cash balance pension plan.

2. AT&T Cash Balance Plan: AT&T’s cash balance pension plan is another example of a major corporation implementing a cash balance program for its employees. The telecommunications giant introduced the cash balance plan to address the specific needs of their workforce, who were no longer expecting to spend their entire careers with a single company. Similar to IBM’s plan, AT&T’s cash balance plan provided employees with individual accounts based on their earnings and service, making it easier for employees to transfer their pension assets should they change jobs.

3. Southern California Gas Company (SoCalGas) Cash Balance Pension Plan: SoCalGas has implemented a cash balance pension plan in addition to its traditional pension plan since the 1990s. The company decided to shift from the older defined benefit pension plan to a cash balance design in order to provide a more portable and flexible retirement option for its workforce. This hybrid plan allows employees to accumulate pension benefits based on their years of service, salary, and a pre-defined interest rate, offering a predictable retirement savings account that can easily be rolled over into an IRA or other retirement plan upon separation from the company.

Frequently Asked Questions(FAQ)

What is a Cash Balance Pension Plan?

A Cash Balance Pension Plan is a type of defined benefit retirement plan offered by employers as part of an employee’s benefits package. It combines some features of both traditional pension plans and defined contribution plans like 401(k)s. In a cash balance pension plan, each employee has an individual account that accrues interest over time, giving them a specified lump sum upon retirement.

How does a Cash Balance Pension Plan work?

In a Cash Balance Pension Plan, employers contribute a fixed percentage of an employee’s salary annually to their account. Additionally, the employer guarantees a fixed rate of return on these contributions. The employee’s account balance grows with these employer contributions and interest credits, providing a stable and predictable retirement benefit.

What are the benefits of a Cash Balance Pension Plan for employees?

Some benefits for employees in a Cash Balance Pension Plan include guaranteed returns, predictable retirement benefits, and portability when changing jobs. These plans often provide less investment risk compared to other retirement plans, as the employer assumes the responsibility of managing the investments and making up for any financial shortfalls.

How are Cash Balance Pension Plans funded?

Employers fund Cash Balance Pension Plans by making contributions based on a percentage of each participating employee’s salary. The employer is also responsible for managing the plan’s investments. The plan’s assets are typically pooled and invested by the employer or contracted third-party investment managers.

Can employees contribute to a Cash Balance Pension Plan?

No, employees cannot make personal contributions to a Cash Balance Pension Plan like they can with a 401(k). Contributions to the plan come solely from the employer, while the employee benefits from the guaranteed return on the contributions.

How are Cash Balance Pension Plan benefits paid out?

Upon retirement or separation from the company, employees can decide to either receive their Cash Balance Pension Plan benefits as a lump-sum payment or convert the account balance into an annuity, which provides a fixed monthly payout for the rest of their lives.

Can an employer offer a Cash Balance Pension Plan alongside a 401(k) plan?

Yes, employers can offer both a Cash Balance Pension Plan and a 401(k) plan to their employees. This dual plan approach allows employees to enjoy the guaranteed returns of a cash balance plan while also benefitting from the flexibility and potential higher returns of a 401(k) plan.

What happens to a Cash Balance Pension Plan when an employee changes jobs?

If an employee leaves or changes jobs before retirement, they generally have the option to either leave the cash balance in the plan, roll the balance into an IRA, or transfer the funds to a new employer’s plan, if allowed. Some plans may also require employees to meet certain vesting requirements before they are eligible to access the balance upon leaving the job.

Related Finance Terms

  • Defined Benefit Plan
  • Employer Contributions
  • Plan Participant
  • Vesting Schedule
  • Annual Interest Credit

Sources for More Information

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