YOU ASK:

How is a cash balance pension plan different from traditional pension plans?

WE ANSWER:

Unlike most traditional pension plans which are either defined-contribution or defined-benefit, a cash balance plan combines some features of both.

By definition, it is a defined benefit plan and as such, it guarantees a benefit of a certain amount for each participant. However, cash balance pension plans act as defined contribution plans in that they are managed through an individual account.

Differences between Cash Balance Plans and Traditional Retirement Plans

Unlike traditional defined benefit plans, cash balance pension plans have accounts with a stated balance which is not affected by any contributions of losses to the account.

Cash balance pension plans permit individuals covered under the plan to have their benefits distributed as a lump sum upon retirement or when they leave their jobs (provided that they are 100% vested). In both cases, the participants' spouses must provide their consent. The lump-sum option is not typically offered by traditional defined benefit pension plans. Individuals who have received their pension plan benefits in a lump sum can opt for converting to an IRA.

The differences between cash balance pension plans and defined contribution plans, such as 401k, are as follows:

  • To participate in a 401k plan, one needs to make contributions to the plan, whereas cash balance pension plans do not require that employees fund their accounts with part or all of their compensation.
  • While in traditional defined contribution plans, such as 401k, employees are permitted to direct their investments, cash balance plan investments are entirely under the employer's control. Thus, the employee takes no risks because the defined benefit is not affected by the ups and downs in the market. Any extra profits the cash balance account may yield, are collected by the employer.
  • Like under all defined benefit plans, cash balance pension plan benefits are protected by the federal government through the Pension Benefit Guaranty Corporation (PBGC). This is not the case with defined contribution plans which are not protected by the PBGC.
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