Cash Balance Pension Plan
A cash balance pension plan is a defined-benefit pension plan with the option of a lifetime annuity. The employer credits a participant's account with a set percentage of their yearly compensation plus interest charges for a cash balance plan. The funding limits, funding requirements, and investment risk are based on defined-benefit requirements. Changes in the portfolio do not affect the final benefits received by the participant upon retirement or termination, and the company bears all ownership of profits and losses in the portfolio.
Definition: A Cash Balance Pension Plan is a type of defined benefit pension plan that includes a lifetime annuity option. Under a cash balance plan, the employer credits a participant's account with a percentage of their yearly earnings plus interest charges. Funding limits, funding requirements, and investment risks are based on defined benefit requirements. Changes in the investment portfolio do not affect the final benefits participants receive upon retirement or termination, and the company assumes ownership of all gains and losses in the investment portfolio.
Origin: The Cash Balance Pension Plan originated in the late 1980s and early 1990s as an alternative to traditional defined benefit plans. It aimed to provide more flexible pension options while reducing the long-term financial burden on employers. In 1999, the IRS issued guidelines on cash balance plans, further regulating their operation.
Categories and Characteristics: The Cash Balance Pension Plan is a type of defined benefit plan with the following key characteristics:
- Account Credits: Employers credit employees' accounts annually based on a percentage of their earnings and a predetermined interest rate.
- Investment Risk: The employer bears the investment risk, and employees' final benefits are not affected by investment performance.
- Lifetime Annuity Option: Employees can choose to convert their account balance into a lifetime annuity upon retirement.
Specific Cases:
- Case 1: A company offers a Cash Balance Pension Plan to its employees. Each year, the company credits employees' accounts with 5% of their annual earnings plus a fixed interest rate of 3%. Employee A has worked at the company for 20 years and has an account balance of $200,000 upon retirement. Employee A can choose to take a lump sum or convert the balance into a lifetime annuity.
- Case 2: A manufacturing company introduced a Cash Balance Pension Plan in 2000 to replace its traditional defined benefit plan. The company credits employees' accounts annually with 6% of their earnings plus an interest rate of 2%. Employee B has worked at the company for 15 years and has an account balance of $150,000. Employee B opts to convert the balance into a lifetime annuity upon retirement, receiving a fixed monthly amount until death.
Common Questions:
- Q: How does a Cash Balance Pension Plan differ from a traditional defined benefit plan?
A: A Cash Balance Plan offers a more flexible account structure where employees can see the growth of their account balance, whereas traditional defined benefit plans calculate retirement benefits based on years of service and salary. - Q: If the company's investment performance is poor, will employees' benefits be affected?
A: No. In a Cash Balance Plan, the employer bears the investment risk, and employees' final benefits are not affected by investment performance.
