Cash balance plans have been an increasingly popular retirement planning tool among small-business employers, particularly law and medical groups. But more larger employers are converting their conventional, old-fashioned pensions, says Alex Pekker, author of a recent report on these plans for management firm Sage Advisory Services.
According to the Department of Labor, there were 7,600 individual cash balance plans in 2010 with $800 billion in assets, compared to 1,300 plans with $426 million in assets in 2000. Within a few years, Pekker predicts that the numbers of cash balance plans could meet or surpass the number of 401(k) plans.
A cash balance plan works like this. The employer commits to putting a “pay credit,” a percentage of each employee’s pay into the plan annually, usually somewhere between 5 percent and 10 percent. The employee also gets an “interest credit.” Interest is calculated based on a predetermined market rate. The most common is the 30-year U.S. Treasury rate, but the rate can be based on a different bond rate or even a stock benchmark.
Compared to an old-fashioned pension, the advantages of a cash balance plan for an employer include greater predictability of cost, less investment risk and less longevity risk. When an employee leaves the company, he can take the lump sum. If he stays long enough to be retirement age, he can take the lump or choose to purchase an annuity.
The employee has no control over how the money is invested and no opportunity to borrow from it as he might from a 401(k), but he doesn’t have to contribute from his paycheck like he does with a 401(k) and he benefits from institutional money management. If he is a high earner, his annual tax-advantaged contribution limit could be more than $200,000 a year, depending on when he was born.
If you are considering taking a job with a firm that offers a cash balance retirement plan, ask what the company’s contribution percentage is. Obviously, the higher the better.
You’ll also want to find out how the interest credit is calculated. A fixed rate, like the 30-year Treasury rate, is low but always positive. Those plans that are linked to a stock market index offer greater opportunities for growth, but they can be more volatile. Pekker explains that the best of these plans elects an interest-credit floor that is greater than zero.
Cash balance plan accounts are protected, within certain limits, by the Pension Benefit Guaranty Corp. Under most circumstances, participants must be fully vested after three years. Paired with another form of savings — a 401(k) or an IRA — these plans could provide an employee with real retirement security.