Companies and their employees continue to explore alternative ways to address financial planning for retirement. One option to consider is a cash balance plan. Cash balance plans work similarly to pension plans in that workers can receive lifetime annuities; unlike pensions, however, a cash balance plan designates an individual account for each covered employee, along with a specified lump sum. These types of retirement plans may also offer potential savings for employers.
Cash balance plans utilize a combination of employer contributions and compound interest over time. Once an employee retires, they can choose to accept the lump sum or to commit to an annuity that will pay out portions of the specified sum in regular checks. Employer contributions for cash balance plans are generally between 5-8%; in comparison, many employers typically contribute 3% to 401(k) plans. Additionally, cash balance plan participants receive an annual interest credit, which can be set at either a fixed or variable rate based on the 30-year Treasury rate.
Cash balance plans also come with the benefit of allowing employees to know how much money they can expect to receive in retirement. Unlike a 401(k), the employer bears the risks associated with market fluctuations, rather than the employee. Cash balance plans are federally insured through a government agency, the Pension Benefit Guaranty Corporation, and must offer the option of a lifetime annuity. Although owners can change or freeze a pension plan, they cannot renege on the benefits an employee has already earned. If an employee opts to receive their cash benefit plan benefits as a lump sum, it can be rolled over into a new employer’s plan or an IRA.
Business owners who establish a cash balance plan for their company and employees will have significantly higher contribution limits than they would with a 401(k). This can be a lifesaver for many employees, especially those who need to play catch-up to prepare for their retirement. Cash balance plans use pretax contributions and compare favorably with 401(k) plans, which have lower contribution limits for both employers and employees.
Having both a cash balance plan and a 401(k) can help plan beneficiaries increase their retirement savings and lower their tax bills. Cash balance plan participants receive regular statements that explain the hypothetical value of their retirement account and how much money they can expect to have in retirement. Employees will have less control if they choose an annuity, but will have peace of mind from knowing they can’t overspend and lose their savings before they plan to retire.
If the company runs into difficulties, employees may face reduced benefits. This is why some employees choose the lump sum option, which can be rolled over into an IRA. If a rollover is chosen, the employee will then be responsible for ensuring that their benefits last throughout their retirement years.
Whether you’re a business owner considering different retirement plans for your company or an employee, it’s worth learning more about cash benefit plans and how they can help secure a financially stable future.