When managing the retirement process, there are pension plans which are long-term investments or savings systems. The cash balance plan is a variation of a defined benefit plan and an employer-sponsored retirement plan.
Before we dive into cash balance plans, we need to know about pension plans and how they work, their objectives, and their benefits.
Defined benefits plan Vs. 401(k) plan
Pension plans define the right to an income or salary when specific plan requirements are met. It differs from an investment fund since, in the latter, money is deposited or withdrawn at will, and the pension plan is designed for certain contingencies such as retirement, widowhood, survivorship, orphanhood, or disability.
Defined benefit plans stipulate from the outset how much the beneficiary will receive from the benefits acquired, i.e., when the relevant requirements for obtaining the pension are met, the amount to be received by the beneficiary is already defined from the beginning.
Therefore, pensioners know how much they should receive.
In the case of defined contribution plans, they are managed through contributions or investments. The employee does not know how much his pension will be, but he does know how much he is contributing; what will determine the amount of the allowance is the yield of the investments. Therefore, it could be more or less than the amount invested.
The 401(k) plan belongs to the defined contribution plans. It is an agreement between the employee and employer that holds the possibility of choosing between receiving a cash bonus or depositing the same percentage in an account called 401k.
Cash balance plan
Cash balance plans are a hybrid between defined benefit plans and contribution plans; employees will have a set balance when they retire or decide to leave the company rather than a fixed monthly benefit.
Employers typically calculate the cash balance on two factors: pay credits and interest credits. The cash balance plan generally calculates benefits for the total years worked at the company, not for the period you earned more or less.
As a custom, companies pay each year in salary credit and receive the credit according to the amount of money in the account. So each year, employees have an annual balance with a salary saved and received when leaving the company. Employees can decide whether to use the balance as an annuity from their enrolled insurance or transfer it to a personal retirement account.
Benefits of Cash Balance Plan
Because it is a hybrid plan between the two traditional pension plans, it ensures a minimum amount to be received, but with contributions or investments that can increase or decrease the investment without touching the minimum amount of the defined benefit plan.
But that is not the only benefit of the cash balance plan; if there are still doubts, here are some aspects that make the cash balance plan the most beneficial program.
Run by trustees
The employer is the benefits provider, but it is managed by a trustee responsible for the recording, payroll, and final payment of the retirees’ benefits. In addition, there is an administrator in charge of the trustee, who is responsible for the management.
More favorable to younger employees
Cash balance plans benefit the employee’s career and grow over time. Early career contributions have more time to accumulate, meaning they will be more valuable over time than when they were invested.
Another benefit is that you have control over your investments and periodically explain the hypothetical value of how much money you may have in retirement to keep track of and know what to expect if you continue such a pace in the investment.