Pension plans are divided into two separate categories: defined benefit plans and defined contribution plans. A defined benefit pension plan guarantees a specific benefit for any eligible retiring employee, while the defined contribution pension plan relies on specific contributions from an employer to their employee’s pension plan account. Cash balance pension plans represent a type of defined benefit pension plan that acts more like a defined contribution plan. There seems to be a lot of confusion as to how those plans actually work.

Generally speaking, cash balance pension plans resemble defined contribution plans by having an employer credit their employee’s retirement account annually. As the employee reaches age 65, he is entitled to receive cash balance plan benefits (which makes cash balance pension plans a defined benefit plan) in the form of a cash balance that it has been deposited into your pension account.

At retirement, people can accept annual payments for the rest of their life in the form of an annuity (usually around 10% of the pension account balance per year) or, alternatively, choose a lump sum benefit to The full pension. account balance. Many plans include the option for people to accept an adjusted lump sum upon leaving work before age 65.

The main difference between these retirement vehicles and traditional pension plans relates to the distinctions made in the definition of benefits. While benefits from the regular pension account will be represented as specific payments to an individual’s pension account in perpetuity (beginning at retirement age), cash balance plans simply define the benefit as a balance of the pension. account (which does not reflect actual contributions, and as such is ‘hypothetical’ in nature until retirement).

Unlike a 401 (k) plan, employee participation with a cash balance plan is not required, as they are benefits received from an employer. Because of this, only the employer bears the risks / rewards of cash balance plans, as regardless of gains / losses on the employer’s part, a person who has been promised a fixed amount for their pension account You will always be entitled to the amount agreed upon upon retirement. This is a key difference from 401 (k) and traditional plans, as people have more control and responsibility over managing risk and rewards.

Guaranteed by the federal government, cash balance plans are insured by agencies such as Pension Benefit Guaranty Corporation (PBGC), which have the power to intervene to act as trustee for any canceled or underpaid defined benefit plan. Defined contribution plans (like a 401 (k) plan) do not benefit from this federal guarantee.