Like any retirement vehicle, there are advantages and disadvantages. Cash balance plan pros and cons are not always clear cut. This is because the public knows less about the plans compared to other retirement solutions.
When it comes to retirement accounts, the idea of having different limits and regulations for each type of account, is to incentivize people to save for retirement, while at the same time restricting them from taking advantage of certain loopholes.
So let’s list out the common cash balance plan pros and cons. Below you will find a list of important benefits, as well as a few negative aspects of the plan.
Cash Balance Plan Pros and Cons: Let’s look at the Upside
Cash Balance Plans were made specifically to benefit small business owners who present unique financial challenges when it comes to saving for retirement. Among those benefits are:
- Ability to contribute higher amounts, depending on your current age.
- You can use a cash balance plan while also contributing to other retirement vehicles.
- Returns on your investment are based on an interest rate charge contributed by your employer, resulting in steady and conservative growth.
Higher Contribution Limits Offered By Cash Balance Plans
Most retirement vehicles only allow you to contribute up to a percentage of your annual compensation. If your compensation is too high, some higher income earners are even disqualified from using other retirement accounts.
A cash balance plan allows you to contribute a much higher amount than other retirement vehicles. This amount is age dependent, allowing older business owners to contribute more and younger business owners to contribute less.
The reason for the age dependence lies in the unique financial challenges presented to small business owners. More often than not, the beginning years of launching a new business require tight finances with less ability to contribute to retirement. The ability to contribute more money to a cash balance plan in later years allows a small business owner to “catch up” in their retirement savings, since they weren’t able to contribute to retirement in the beginning years of business.
Cash Balance Plans Can Be Used In Conjunction with Other Retirement Plans
Not only are you able to contribute more to a Cash Balance Plan, you can take advantage of other retirement vehicles like a Roth or Traditional IRA, or a 401(k). Each of these accounts have contribution limits, presenting you with an even higher cash balance plan contribution limit.
Interest Rate Charge Contributions by Your Employer
Specified in the Cash Balance Plan documents through your employer, you will find a stated interest rate charge that refers to the amount your employer will pay into the plan for you as a form of return on investment.
While other retirement vehicles are totally dependent upon the stock market, cash balance plans have a lower return, and are made through the employer contributions. This makes for a more conservative return and a steadier growth of your principle balance.
Cash Balance Plan Pros and Cons: Let’s look at the Downside
Keep in mind there are a few negative aspects of a Cash Balance Plan worth noting when weighing out your options. Among the cons of using a Cash Balance Plan are:
- Cash Balance Plans require additional cost requirements for employers
- Inability to direct the fund investments as an employee
Additional Cost Requirements of Cash Balance Plans
Employers who want to offer a Cash Balance Plan are required to insure the funds by the Pension Benefit Guaranty Corporation (PBGC). This adds to the cost that an employer pays if they so choose to offer this type of retirement option.
Higher costs result in potentially lower returns and options within the company retirement products.
Inability to Direct Fund Investments as an Employee
You may be familiar with how a solo 401(k) or an IRA works, in that you can choose from a selection of investment options you wish to invest in. Each option allows you to allocate your investments to a more risky investment objective or a more conservative objective.
Cash balance plans do not offer fund investment choices. In fact, each established account is set aside as a “hypothetical” account for each contributing employee. At the end of each year, the employee receives a statement of their contributions and return on investment.
The fund balance is professionally managed by the sponsoring investment firm, leaving you with no options in how the funds are invested. To some this may be a good thing, others, may wish to have more control over their retirement money.
Consider Your Options
It’s always a good idea to investigate the cash balance pros and cons in addition to those offered by other retirement vehicles. With the different benefits offered by each different type of vehicle, it’s also a good practice to diversify your investments and your investment vehicles. This is, among many others, one of the many benefits of using a cash balance plan.