Cash Balance Plan Withdrawal Options: Mistakes to ‘Avoid’ [+ Pitfalls]

Most people with cash balance plans are excited to make the contributions. They want the large tax deductions. But how much do you know about the cash balance plan withdrawal options?

Cash balance plans typically do not allow partial withdrawals. If your employment has been terminated, you may take your vested amount balance. You can even take a cash distribution and pay taxes on it, along with a 10% early-withdrawal penalty if you’re younger than age 59 ½.

If you have a cash balance plan, you have a few options for withdrawal. Like a 401K, you must be of retirement age according to the plan documents and you must be vested, which by law can be no longer than 3 years.

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With a cash balance plan, you get paid a ‘pay credit’ which is a percentage of your salary that remains the same each year. You also receive an interest credit which is predetermined by your employer and also doesn’t change.

The employer takes the risk of the investment performance. You don’t have to worry about whether an investment performs or not. The employer takes that risk and must make up the difference if there is an imbalance.

But how do you withdraw your funds? We discuss your options in this post.

Cash Balance Plan Withdrawal Options

While the goal is for you to stay at the same company through retirement, we rarely see that anymore. Unlike traditional pension plans, though, cash balance plans can move with you.

If you make a withdrawal and keep the money, you will pay tax on the distribution. In addition, you will have a 10% early distribution penalty. While 20% of your funds are withheld, you still owe taxes and penalties, which will likely be more than the 20% withholding.

Taxable WithdrawalTax-Free Withdrawal
Conversion to RothRollover to IRA
Distribution Upon RetirementQualified Plan Rollover
Taxed as Ordinary IncomeAvailable While In-Service
Reversion for OverfundingRollover to 401(k)

If you leave your job after the vesting period (usually 3 years), you can roll over the balance into an IRA or a 401K at your new job if they’ll allow it. Unlike a 401K, most companies don’t allow you to withdraw funds early for personal use, aka not roll them over into a qualified plan.

The nice thing about rolling the funds over is you don’t have to worry about taxes. You don’t owe any taxes on the contributions or earnings until you withdraw them for personal use during retirement.

If you are eligible for any early withdrawals that you don’t roll over, you will pay taxes at your current tax rate on the earnings.

Getting Around the Early Withdrawal Rules

If your cash balance plan doesn’t allow for early withdrawals but you need one, there is a way around it.

If you transfer the funds to an IRA or 401K when you change jobs, you have more access to the funds. While it’s not recommended, you can take an early withdrawal before age 59 ½ from either an IRA or 401K.

cash balance plan withdrawal options

You’ll pay a 10% penalty charge plus you’ll pay taxes at your current tax rate. Since most people are at a higher tax rate now than they would be during retirement, you’ll likely pay higher taxes taking this route so only withdraw funds early if it’s absolutely necessary.

Lump Sum Withdrawal at Retirement

The lump sum withdrawal is often the most common method for the cash balance plan and sometimes it’s the only option employers allow.

A lump sum withdrawal means you can take the entire balance of the account at retirement and invest it how you want.

The Risks of Lump Sum Withdrawal

It’s important to consider the risks of the lump sum withdrawal. Because you’re receiving the entire amount at once, you could blow through it and have nothing left during retirement. That’s something you have to be able to manage and know that you won’t overspend.

You also have the option to reinvest the funds. That has its pros and cons as well. The benefits, obviously are that you can increase your earnings, ensuring you have enough for retirement. The downside, though, is that you could make poor investment choices and lose more money, decreasing the amount you have for retirement.

Annuity Payments

If your employer allows it, you may also elect annuity payments. This means you’ll receive equal payments monthly for the remainder of your life.

With an annuity payment, there is less risk of using the money incorrectly because you won’t receive it all at once. Instead, you’ll receive level payments that help you cover your monthly cost of living.

The Risks of Annuity Payments

Even annuity payments have their downsides. Even though the payments are guaranteed for life, there isn’t a guarantee the company will stay in business. While cash balance plans are covered by the Pension Benefit Guarantee Corp, they limit their coverage to a specific monthly amount which might mean you don’t receive the full payments you’re entitled to receive.

Cash Balance Plan Withdrawals

If your employer doesn’t have an annuity option, you can work around it. First, take the lump sum distribution and roll it into an IRA.

Next, you’ll buy an immediate annuity. This product, which you get from an insurance agency, begins paying you monthly payouts immediately. You get guaranteed income monthly, which is much like what the annuity would have done for you if your employer offered it.

Keep in mind, the immediate annuity is not a tax-sheltered investment, though.

Can you take money out of a cash balance plan?

If you don’t use the entire amount to buy the annuity, you give yourself the best of both worlds. You get the traditional monthly payment, so you have some guaranteed income plus you have a cushion.

You can invest the remaining funds either in an IRA or other type of investment, however, an IRA would be tax sheltered, triggering a tax liability only when you withdraw funds.

How are retirement distributions taxed?

Retirement distributions can be taxed differently depending on the type of retirement account from which they are taken and the individual’s tax situation.

  1. Traditional IRA or 401(k) distributions: Distributions from traditional IRAs or 401(k) plans are generally taxed as ordinary income when they are withdrawn. The amount of tax owed on the distribution will depend on the individual’s tax bracket.
  2. Roth IRA or 401(k) distributions: Qualified distributions from Roth IRAs or Roth 401(k) plans are generally tax-free because the contributions to these accounts are made with after-tax dollars. However, suppose the distribution needs to be qualified (i.e., taken before the individual reaches age 59 1/2 or does not meet other requirements). In that case, the earnings portion of the distribution may be subject to income tax and a 10% early withdrawal penalty.
  3. Social Security benefits: Social Security may be taxable if an individual’s provisional income (defined as AGI plus nontaxable interest plus half of Social Security benefits) exceeds certain thresholds.
  4. Pension or annuity payments: Pension or annuity payments are generally taxable as ordinary income. Still, a portion may be excluded from taxation if the individual made after-tax pension contributions or annuity contributions.

It’s important to note that tax laws can change, so it’s critical to consult a tax professional or financial advisor for specific guidance on how retirement distributions will be taxed in your individual situation.

What is the Withdrawal Process?

How do you withdraw funds from a plan?

  1. Consider why the withdrawal is necessary

    Determine why the withdrawal is required. Is it because the participant is leaving the company and has a vested balance? Or is the plan terminating. Maybe the participant needs funds for an emergency. There could be a variety of reasons and it may not be required to take a taxable distribution.

  2. Determine which custodian will receive the proceeds

    Since the distribution amount will be rolled into another qualified plan, make sure you have a custodian to accept the funds. You might need to set up an account at a provider like Schwab, Vanguard, or Fidelity. Thanks to flexible rollover rules you have plenty of options.

  3. Verify the rollover at the custodian

    The current investment custodian with help from the administrator will examine and approve the final vested account balance. Form 1099-R will be issued to the recipient at the end of the year. If the distribution goes directly from one custodian to another, the withdrawal will show as non-taxable on the 1099-R.

  4. Finalize rollover paperwork

    The business will receive distribution forms from the TPA that must be signed. These forms will instruct the investment custodian to release any funds. In most cases, the TPA will assist with the distribution.

  5. Verify receipt of funds

    Receipt of funds can often take a week and may not happen overnight. Processing time will vary depending on the time of year and the custodian backlog. Once received, you must verify the amount equals the vested balance, net of any transaction fees.

Final Thoughts

You have options when withdrawing money from your cash balance plan. Ideally, you’d leave the funds until you retire and take either a lump sum or annuity payment.

How you take the funds depends on how you plan to manage your money. If you’re good at managing investments, you may consider rolling it over to an IRA and taking withdrawals as needed. This way your money can still grow while you have enough money to live off of monthly.

If you aren’t good at managing funds or want a guaranteed monthly payment, the annuity option can be a better choice. Either way, make sure you understand the tax liabilities of taking the funds and try to avoid withdrawing funds before retirement age, so you don’t lose 10% of your balance to the penalty charges.

Paul Sundin

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