Episode #32: Cash Balance Pension Plans 101

Cash Balance Pension Plan

July 7th, 2020

What is a cash balance pension plan? What do you do with a cash balance pension plan? How is money contributed and how is it dispersed when you retire? In this episode of Making Finance Fun, I answer some frequently asked questions about this specific type of pension plan. If you work at the Hallmark Cards Inc. facility in Metamora, IL—this episode is for you! 

Outline of This Episode

  • [1:30] Just what is a cash balance pension plan? 
  • [2:47] What does all this mean?
  • [3:54] What makes cash balance pension plans unique? 
  • [8:21] The pros + cons of monthly payments
  • [9:58] The pros + cons of the lump sum option
  • [11:17] What does your final decision come down to?

Just what is a cash balance pension plan? 

According to Investopedia, A cash balance pension plan is: “A pension plan with the option of a lifetime annuity. For a cash balance plan, the employer credits a participant’s account with a set percentage of their yearly compensation plus interest charges.” They also note that changes in the portfolio will not affect the benefits received by the participant when they retire or are terminated. 

So what does all this mean? There are generally two types of benefit plans: There is a defined contribution plan such as a 401k or 403B where you’re the one contributing the money and your employer may or may not match it. This is what most people are familiar with. Then there are defined benefit plans, where you have upon retirement a specific defined benefit dispersed monthly or in a lump sum. The second category is where a cash balance pension plan lands. 

The key difference between the two types of plans

The biggest difference about a cash balance pension plan is that you—the employee—are not contributing money into the plan. Another difference is that each participant has their own account vs. one large pension that’s dispersed among all participants. The employer contributes a specified amount each year, typically a percentage of their yearly compensation (i.e. it could be 5%). There will also be an interest credit that will be applied. These types of plans also give you two choices for disbursement of the funds once you retire or are receiving a severance package. 

Option #1: a guaranteed monthly payment

The first option for the disbursement of a cash balance pension plan is monthly payments. Commonly, you are offering a guaranteed monthly payment of a specified amount until the day you die. You may also have the option of choosing how the amount is distributed—such as split between you and a spouse, a higher monthly amount for 10 years, etc. At this time, I’ve only seen this for Hallmark Cards Inc. employees.

So how do you decide if this is the right option for you? Think about your monthly expenses during your retirement. Do you need an extra dollar amount per month? Will your social security be enough to cover your expenses? Or you just haven’t saved enough? The monthly payments may be the route to take if you NEED the guaranteed payments. What are the possible disadvantages of this option? What happens to the money if you pass away? Listen to find out!

Option #2: taking one lump sum

The second option for the disbursement of a cash balance pension plan is taking the money in one lump sum. The biggest advantage is that you can take that lump sum and do whatever you want with it. You can roll it into an IRA, you can use it to pay off debt, or even towards vacations. The bottom line is you can spend it however you like. The downside is that there aren’t a lot of investments that can guarantee you a monthly payment for the rest of your life that the first option offers. You’ll also likely be charged taxes on the lump sum. 

So what does it boil down to? Really, it’s what is most important to you. It’s a highly personal decision. If you’d prefer a lump sum to do with as you please then go that route. If you would like a guaranteed monthly payment for life to help with necessities then that’s a great option as well. 

If you participate in a cash balance pension plan—such as Hallmark Cards Inc. employees—I highly recommend connecting with a certified financial planner (even if it isn’t me) with experience with these plans. What you decide is a choice that will impact the rest of your financial future, so you want to choose wisely. A financial planner can help. If you have more questions, feel free to reach out!

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