A cash balance plan is a type of retirement plan that combines features of both traditional pensions and 401(k) plans. In a cash balance plan, each participant has an account balance, similar to a 401(k) account, but the employer makes contributions and the benefits are typically based on a percentage of the participant’s salary and years of service, like a traditional pension plan.
How does a cash balance plan work?
1. Contributions: Employers make contributions to each participant’s account, usually based on a percentage of their salary. These contributions are invested by the plan administrator.
2. Guaranteed interest credit: In addition to the contributions, participants also receive a guaranteed interest credit on their account balance, similar to the interest earned on a savings account. This ensures that the account balance grows steadily over time.
3. Vesting: Like a 401(k) plan, participants in a cash balance plan are always fully vested in their own contributions. However, vesting in the employer’s contributions may be subject to a vesting schedule, which determines how much of the employer’s contributions the participant is entitled to keep if they leave the company before retirement.
4. Distribution: When a participant reaches retirement age or leaves the company, they can choose to receive their account balance as a lump sum payment or convert it into an annuity that provides regular payments for the rest of their life.
Overall, cash balance plans offer a flexible and secure way for employees to save for retirement, with guaranteed benefits and the potential for investment growth.