Let’s start with the basics: A cash balance plan is a defined benefit plan. It’s a little different from what a traditional one is where you put money into a plan and at the end of the day, when you get to retirement age, you get an annuity for life or for the life of you and your spouse. This is different, a cash balance plan looks and feels like a savings plan or a 401k savings plan, you put in a contribution credit and let’s say you’ve funded the two ways. One way is put in a contribution credit that’s in the planned document, usually as a percentage of pay. The other way is with an interest credit. Back to the basics, it is a plan and in the plan document there will be an interest credit that is usually around 4 or 5% that is not directly tied to your assets. That is the amount you will get regardless of what the assets in your account do, which is how you are able to build up an account. You can then take money out from this cash balance account just like you would from a savings account, once you hit retirement.
An easier way to think about a cash balance pension plan is that it combines both a defined contribution plan and a defined benefit plan. A defined contribution plan is not defined by what age you are, how much money you’re making, it is purely a percentage of assets that you’re allowed to put away, with a maximum cap that you can put away from your own salary as well as a percentage that an employer could give to you and put in an account, that will help that account to grow as much as you can. In short, a defined benefit plan is based upon your age, your salary, and a couple of other details that are standard procedure. So the closer you are to this age, the more money that you need to generate an annuity for the rest of your life. So a cash plan combines both, allowing you to reap the benefits of both these account structures.
In hindsight, you are getting the best of both worlds by using this account but to dig deeper, why would anyone want to use a cash balance plan rather than a defined contribution plan?
These answers and more are explained in the newest episode of Life Unlimited with my special guest David Yackel from Pension Review Services. Join the conversation now: https://bit.ly/LUep121