Cash balance pension plans explained

In the world of employer-sponsored retirement plans, you're likely familiar with 401(k)s and pensions. However, another increasingly popular option slides in between the two: cash balance pension plans.

Cash balance pension programs offer the stability and structure of traditional pensions and can be an ideal companion for a 401(k).

To help you determine if it's a good option for you, we'll dive into what cash balance pensions are, how they work, how they compare with 401(k) retirement plans, and their overall pros and cons.

A cash balance pension plan is a type of defined benefit plan that combines the features of traditional pension plans with those more commonly found in individual retirement accounts.

With a traditional pension plan, you receive a set benefit when you retire that's based on your salary and length of employment by the company. With a cash balance pension, your retirement benefit is stated in advance, and you earn salary-based credits toward that benefit every year you remain with the company.

When you retire or leave the company, you have three choices for receiving your pension plan payout:

1. A lump sum. If you choose the lump sum option, you get immediate access to your money, but you must pay ordinary income tax on the entire amount. This can be costly, so it's important to weigh the tax implications before choosing this option.
2. An IRA rollover. If you do a direct rollover of your pension payout into an IRA, you won't have to pay any taxes until you start making withdrawals during retirement. This option also could give you an opportunity to invest your money within the IRA.
3. Annuity payments. If you want a predictable stream of retirement income, you can convert the value of your cash balance pension account into fixed monthly payments. This option can help with your budgeting and ensure that funds last through your retirement years. Be aware, though, that you might not have the annuity option if your account balance is below plan minimums. In that case, you may have to take a lump-sum distribution or rollover.

Some cash balance programs may let you choose a combination of these benefits. For example, you could choose a 25% lump sum payment and roll the remaining balance into an IRA.

The employer credits the company's main pension fund each year with a fixed percentage of each participating employee's salary. This is known as a pay credit, and the percentage is stated in the plan's documentation.

The main fund also earns interest annually. That's called the plan's interest credit, which can be a fixed or variable rate. The interest credit ensures that the pension fund grows sufficiently to allow the defined retirement benefit—stated in the plan documents—to be paid to employees at retirement.

You'll see your account balance on an individual statement. Your balance takes into account your salary—which determines your pay credits—and your time with the company. The balance you see is called your hypothetical balance because it's tracking the future retirement benefits you're accumulating over time. You'll get that amount if you stay with the company until you reach retirement age, providing you meet your plan's vesting requirements. You can refer to your plan's documentation for vesting requirements (typically three to five years of employment) and payouts should you depart a company prior to retirement age.

The important thing to know about cash balance pensions: Your defined retirement benefit is never impacted by fluctuations in the pension fund's performance. Your employer must pay the stated benefit, regardless of whether investments lose or gain value.

Say you work for a company with a cash balance program, which offers a 4% pay credit and a 4% interest credit. If your salary is $80,000, here's what the first year looks like:

• Pay credit: Your employer contributes $3,200 to your account (4% of $80,000).
• Interest credit: That contribution earns a guaranteed 4% interest, or $128.
• Hypothetical balance at end of first year: $3,328.

The longer you work at the company, the higher the balance of pay credits and the more you'll earn in interest. Over time, your account gradually builds to the retirement benefit value your company promised. It's the company's responsibility, not yours, to ensure that the account grows at the correct pace.

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Explore your options 

Cash balance pension plans and 401(k)s differ in a few key structural details, including who contributes, who takes on the risk and how much can be contributed. Note that employers may offer both a cash balance pension and 401(k), and employees can participate in both. Each has different advantages that can help diversify and maximize your retirement strategy. Here are the top comparison points to consider when weighing cash balance pension plans vs. 401(k)s:

A cash balance pension is a defined benefit plan while a 401(k) is a defined contribution plan. Defined benefit plans are funded only by the employer. Defined contribution plans are offered and managed by the employer, but they're primarily funded by the employee—although employers can also contribute, in the form of a match up to a percentage.

There's also a difference in who bears the risk with each plan. With a cash balance program, it's the employer. They must ensure that the account growth aligns with the guaranteed retirement benefit. With a 401(k), the employee bears the risk. The employee selects the investments, and their account balance depends on their performance. There are no guarantees with a 401(k).

With a cash balance pension, employer contributions are limited to a certain percentage of your salary. With a 401(k), employee contributions can be considerably higher. For example, let's say your cash balance pension plan requires your employer to contribute 5% of your salary annually. If you make $80,000, they'll contribute $4,000 to your account. However, with a 401(k), a plan participant younger than 50 could contribute up to $23,000 in 2024 and $23,500 in 2025.

Cash balance pensions offer participants plenty of advantages, especially since the employer bears all the investment risk. However, these plans also have potential drawbacks. Knowing the pros and cons can help you evaluate your employer's retirement plan options and decide which plans best align with your savings goals.

• Various payout options—lump sum, rollovers or annuity payments
• Guaranteed retirement benefits
• Tax-deferred contributions and growth
• No salary deductions

• Taxable distributions
• No ability to make employee contributions
• Limited investment control
• Potentially lower returns than a 401(k)

Cash balance pension plans may offer a level of security and safety that can be attractive when you're thinking about retirement savings. If you're weighing whether a cash balance pension, 401(k) or other type of employer-sponsored plan is right for your goals, chatting with a local Thrivent financial advisor can help. Together, you can review your current savings and discuss your goals—then chart a path that protects and supports what's most important to you.