Cash balance pension plans are a hybrid of a traditional pension plan and a defined contribution plan like a 401(k). With a cash balance plan, you get the right to annual payments in retirement without having to manage your own money, just like with a traditional pension. However, you also build up a cash balance that you can take as a lump sum in retirement if you prefer. You can also withdraw it before retirement under limited circumstances.
Your Plan's Balance
The balance of your plan comes from two different types of contributions. First, you get a "pay credit" every year that is equal to a percentage of your salary and reflects your or your employer's annual contribution. Second, you get an "interest credit" every year that reflects the rate of return on your investment. These credits are set by your employer and may or may not be the actual rate that the market returns. Your employer takes that risk and guarantees your return. The balance of your plan is based on these amounts. Your benefits also have to be fully vested within three years of when you start funding your plan.
Distributions in Retirement
Once you reach retirement age as defined by your plan, you are eligible to pull out money in one of two ways. Like a traditional pension, you can choose an annuity that makes regular payments for the remainder of your life. You can also opt to take a lump sum out of your plan and invest it however you see fit, if your plan allows lump sum distributions. The mechanics of pulling money out of your plan are defined by your plan administrator, but will usually involve filling out some paperwork or completing online forms.
Unlike a traditional pension plan that doesn't go with you when you leave job, your cash-balance plan's balance can be rolled over if you and your employer separate. Any vested balance can be directly transferred into an Individual Retirement Account without you having to pay taxes on it. You can also choose to take a lump sum distribution when you retire and roll it over to an IRA or other account tax-free.
Your employer can lock up your cash-balance funds so that you cannot take an early withdrawal other than through a rollover. If you are eligible to rollover your retirement plan, you might be able to structure it as a cash distribution to you. If you keep the cash, you will have to pay income tax on the distribution as well as paying an additional 10 percent penalty for the early withdrawal. While 20 percent of your balance will be withheld, you owe your actual taxes and penalties, which could be more than 20 percent.
- AARP: Cash Balance Plans: A New Approach for Pensions
- Department of Labor: FAQs About Cash Balance Pension Plans
- MarketWatch: Cash-Balance Pension Plans Are Growing Fast
- MarketWatch: Could This Plan Replace the 401(k)?
- CNN Money: Ultimate Guide to Retirement -- When Can I Get Access to the Money?
- Prudential: Understanding Cash Balance Retirement Plans
- Department of Labor: FAQs About Retirement Plans And ERISA
- Diageo: Your 2013 Employee Benefits
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