One of the most trusted and relied upon types of retirement plans is the 401(k), a plan offered by many businesses to their employees and, indeed, a retirement plan that people have been using for a long time years to fund their ‘golden years’ because of its low risk and high yield. That being said, there’s a pension plan that has been growing in popularity since the early 1980s that is slowly but surely overtaking the traditional 401(k) as a retirement plan option due to the fact that it’s easy to take from one job to the next, is a bit simpler as far as how it works and is a better option for someone who has gotten a late start on their retirement savings plan.
This plan is called a Cash Balance Plan or CB and it’s a hybrid pension plan that has been getting a lot of interest since about 2000. In fact, in the year 2000 there were approximately 1,300 CB plans and they held about $426 million in assets. That number had quintupled by 2010 when there were 7600 plans with a total value hovering just around $800 billion. The question that any retirement investor must ask then is why has the number of people participating in a number of CB plans grown so much in the last 10 years?
There are several answers but one of the most important reasons for their growing popularity is that CB plans have a high amount of ‘portability’, meaning that they can be easily taken from one employer and brought to the next. When a person leaves one job to go to a new one, unlike with a 401(k), they can actually withdraw the full amount of their Cash Balance Plan. The reason for this is that, unlike a 401(k), a CB plan has both a defined benefit and a defined contribution aspect to it, something that a 401(k) does not.
What this means is that, since it is essentially a hypothetical account, the entire account balance of a CB can be easily rolled over when the participant leaves their employment whereas someone who has a 401(k) will either have to wait until they retire to withdraw funds or draw them as an annuity. With a CB, whoever is sponsoring the plan will contribute to it based on a set interest crediting rate.
The fact that they have reduced load activity and low risk level is another reason that CBs are gaining in popularity on 401(k)s. For someone that is starting a retirement savings plan late in their life this can be a big advantage. It can also be advantageous if your pay is relatively high and the fact is that most CB plan participants earn $250,000 a year or more.
That’s not to say that a CB plan is not without its flaws. Typically, a 401(k) has a lower level of risk but this depends on the company that is sponsoring the CB and can vary widely. Although not related to risk, the participant’s cash flow and the current interest crediting rate will also need to be factored in and will cause the structure of the CB to vary. Setting up a CB, at least for the plan sponsor, can also be quite complicated and laborious. Most experts will tell you that you should peg the liability of your investment to the balance of your CB account balance.
In the end however, a CB plan is generally a lot easier to comprehend for the retirement investor and, if there is a capable plan sponsor and an investment strategy that is skillfully planned out, a cash balance plan can be a superior option as far as pension plans go for many employees.
