Cash Balance Pension vs. 401(k) Retirement Plans

Friday, April 26, 2013

 

According to a recent report by Sage Advisory Services, a leading Texas-based investment management firm, Cash Balance Pension Plans have the potential to overtake 401(k) Retirement Plans in the foreseeable future.  While many organizations have terminated or frozen their traditional defined benefit pension plans, others have explored cash balance plans.  The US Department of Labor, Employee Benefits Security Administration describes a cash balance plan this way.

 

“In a typical cash balance plan, a participant's account is credited each year with a "pay credit" (such as 5 percent of compensation from his or her employer) and an "interest credit" (either a fixed rate or a variable rate that is linked to an index such as the one-year treasury bill rate). Increases and decreases in the value of the plan's investments do not directly affect the benefit amounts promised to participants. Thus, the investment risks are borne solely by the employer.”

 

So in many ways, a cash balance pension plan, although still a defined benefit style plan, appears to employees as having many of the same attributes as a 401(k) plan.  Employees in a cash balance pension plan do not have actual segregated, delimited, and individual accounts, instead their accounts are “notional”.  Nevertheless, the employee perceives value changes, gains, and losses in their “account” with contributions deposited, interest earned, and investment gains and losses posted.

 

If cash balance plans as so similar to 401(k), why even bother with a 401(k)?  Cash balance plans are still a defined benefit pension and suggest to the reporting, minimum funding, and actuarial rules as traditional defined benefit pension plans.  Cash balance plans generally do not permit employee contributions, thus the responsibility for funding falls squarely on the employer.  Nevertheless, cash balance plans are a tool in an organization’s effort to attract and retain top talent along with cash compensation, non-cash rewards, health and welfare benefits, and paid time off.

 

Such an arrangement as a cash balance plan is often highly attractive to younger, investment savvy, and more mobile employees.  These employees are also often the very employees that an employer wants to source and recruit.  Compared to more traditional defined benefit pension plans which can have complex benefit formulas, cash balance plans can be simple and straight forward.  Many offer portability of accrued account balances in the event an employee separates from their employer before retirement age.  A traditional plan, on the other hand, might require a separated employee to wait until age 55, 62 or 65 before their benefit could be distributed.