Cash balance plans are a type of defined benefit pension plan that is designed to provide retirement income to employees. These plans are funded by contributions from the employer, and the benefits that a participant will receive at retirement are typically based on a formula that takes into account factors such as the participant’s salary and the length of their service with the employer.
Top cash balance plan risks:
- Investment Risk. Investments are managed by the company, or an advisor appointed by the employer. The company bears all investment risk. This is because increases and decreases in plan assets do not affect the employee benefit amounts.
- Vesting Risk. Many companies set up plans with 3-year vesting. As such, they anticipate turnover to make the plans economical. If employees do not leave the company based on historical norms, the employer has the risk of making higher contributions.
What is the risk to a cash balance plan?
Like any investment, cash balance plans involve some level of risk. Some of the risks that may be associated with cash balance plans include:
- Investment risk: Cash balance plans are typically invested in a mix of assets, such as stocks, bonds, and cash. The value of these investments can fluctuate, and there is no guarantee that the plan will achieve a positive return. If the investments in the plan do not perform well, it could impact the benefits that a participant receives at retirement.
- Interest rate risk: Cash balance plans often use a “interest credit” to determine the benefits that a participant will receive at retirement. The interest credit is based on a guaranteed interest rate that is set by the plan. If the interest rate falls, it could result in lower benefits for participants.
- Credit risk: If the employer that sponsors the cash balance plan experiences financial difficulties, it could impact the ability of the plan to meet its obligations to participants. This is known as “credit risk,” and it is a concern for any defined benefit pension plan, including cash balance plans.
- Legal risk: Cash balance plans have been the subject of controversy and legal challenges in the past, and there is a risk that the plan or the employer could be sued by participants or former employees. This could result in additional costs for the plan and could potentially impact the benefits that participants receive.
It’s important to note that the risks associated with cash balance plans may vary depending on the specific plan and the investments that it holds. If you have questions about the risks associated with your cash balance plan or how to manage them, it’s a good idea to consult with a financial professional or a qualified legal advisor. They can help you understand the risks involved and assist you in making informed decisions about your retirement savings.
Investment risk
A cash balance plan is a defined benefit pension plan that combines elements of traditional defined benefit plans with those of defined contribution plans, such as 401(k)s. In a cash balance plan, the employer contributes a fixed amount, or “cash balance,” to an account for each employee, which earns a guaranteed rate of return.
| Top Risks | Top Rewards |
|---|---|
| Investments Must be Conservative | Tax-Deductible Contributions |
| Overfunding Issues | Combine With a 401(k) Plan |
| Minimum Funding Requirements | Min/Max/Target Funding Range |
| Plan Permanency | $100k Plus Funding |
The employee’s account balance is portable and can be taken with them if they leave the company.
When it comes to investing the funds in a cash balance plan, there are several strategies that employees can consider:
- Diversification: One important strategy is diversifying the cash balance plan investments. This helps mitigate risk by spreading investments across different investment classes, such as stocks, bonds, and cash.
- Risk tolerance: Employees should consider their own risk tolerance when choosing investments for their cash balance plan. Some employees may be comfortable with higher-risk investments with the potential for higher returns, while others may prefer lower-risk investments that provide a more stable return.
- Long-term perspective: Employees must keep a long-term perspective when investing in a cash balance plan. The investments in the plan are intended to provide retirement income, which may only be needed for a few years. This means that employees can afford to take on more risk in their investments in the early years of their career when they have a longer time horizon.
- Professional advice: Employees may want to seek professional financial advice when making investment decisions for their cash balance plan. A financial advisor can help employees understand their options and develop an investment strategy tailored to their individual needs and goals.
Overall, a good investment strategy for a cash balance plan involves diversification, considering risk tolerance, maintaining a long-term perspective, and seeking professional advice.
