Cash Balance Plans: A New Approach for Pensions - Aarp

Cash Balance Plans: A New Approach for Pensions Each type of pension plan has its own rules. The rules make a difference in how fast you can save the money you need to reach your retirement goals. Cash balance plans are a new type of pension plan that has emerged in the last few years. They have different rules from both traditional pensions and 401(k)-type plans. Some employers have changed their traditional pension plan into a cash balance plan and others may do so in the future. To see if you have a cash balance plan and to make sure you know how it works, ask your company’s human resources department for the Summary Plan Description (SPD). There are two

basic types of retirement plans for employees. One is the traditional pension plan, also known as a defined benefit plan. In this case, the employer puts all the money into the pen- sion account and invests the money. (For more information, refer to AARP’s Money Matters Tip Sheet on Pensions.) The second type of pension plan is called defined contribution. The most com- mon example is a 401(k). With this type of plan, you decide how much to contribute and you get a tax deduction for the money you contribute. (For more information, refer to AARP’s Money Matters Tip Sheet on 401(k) plans.) How Cash Balance Plans Work The cash balance plan combines some features of a traditional pension, and some features of a 401(k)- type retirement account. Here are the key points: • Your employer deposits a “pay credit” and an “interest credit” into an account for you every year. For example, your pay credit may be 6 per- cent of your salary; the interest credit may be 5 percent of your account balance. • You generally don’t have to put any money into the account. The employer invests the money. • You cannot access to the money unless you are “vested,” meaning that the company cannot take away or reduce the benefit that you’ve earned. The company must vest you in three years. • When you leave your job, you are entitled to the sum of the money that’s been put away for you while you worked for that employer. • You can choose how to take the money—as a yearly payment for the rest of your life, or in a lump sum. If you take the lump sum, you may transfer it into a 401(k) at your new job, or into a Rollover IRA. Cash Balance Benefits A cash balance plan is considered a defined ben- efit plan and must follow general rules that the govern ment sets for these plans. But, there could be a big difference between the amount of money recieved from a traditional pension versus a cash bal- ance plan. • The formula in either plan typically gives you credit for each year you work. With a traditional pension, your benefit is based on your final average pay. The formula typically gives you more credit for working more years. Typically, your highest earnings are in the final years you work for your employer,...

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