Cash Balance Pension Plans.pdf - MBM Advisors, Inc.

What is a cash balance plan? There are two general types of pension plans: Defined Benefit Plans (DB) and Defined Contribution Plans (DC.) In general, defined benefit plans provide a specific benefit at retirement for each eligible employee, while defined contribution plans specify the amount of contributions to be made by the employer toward an employee’s retirement account. In a defined contribution plan, the actual amount of retirement benefits provided to an employee depends on the amount of the contributions as well as the gains or losses of the account. A cash balance plan is a hybrid between a DC plan and a DB plan. It is legally a DB plan that looks like a DC plan. Therefore, the DB

limits apply, i.e., the annual contribution on behalf of any participant is not limited to the DC maximum annual addition of $51,000* in 2013. Instead, the ultimate retirement benefit cannot exceed the DB limit for an annual benefit at retirement of $205,000* in 2013. That maximum benefit is equivalent to a lump sum amount of approximately $2.5 million at age 62. A theoretical account balance (TAB) is maintained on behalf of each participant. On an annual basis, the TAB is credited with a compensation credit and an interest credit. The compensation credit can be a flat dollar amount or a percentage of pay and can vary by employee. The interest credit is often indexed to a widely used measure, such as 30-year U.S. Treasury Securities, or can be a fixed market rate of interest. The compensation credit and the interest credit are guaranteed to the employee. That is, the amount that the employee will receive from the plan is defined. If the plan earns more or less than the interest credit, future contributions made by the employer may be increased or decreased but the participants’ TABs are not affected. How do cash balance plans work? 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 a 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 and rewards on plan assets are borne solely by the employer. When a participant becomes entitled to receive benefits under a cash balance plan, the benefits that are received are defined in terms of an account balance. For example, assume that a participant has an account balance of $100,000 when he or she reaches age 65. If the participant decides to retire at that time, he or she would have the right to an annuity. Such an annuity might be approximately $10,000 per year for life. Cash Balance Pension Plans...

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