401k’s are so Yesterday: There’s a New Retirement Player in Town
Are traditional 401k retirement plans about to be overshadowed by the growing popularity of a simpler and more portable pension plan? Although cash balance plans, or CBs, have been around since the early 1980s, interest in these hybrid pension plans has been growing exponentially over the past ten years.
According to Department of Labor statistics, there were 1,300 CB plans with a total of $426 million in assets in 2000. By 2010 the number of plans had increased to 7,600 plans with a value of just under $800 billion. So why has the number of participants in CB pension plans been steadily increasing?
One reason for the growing popularity is the plan’s portability. Unlike a 401k, a participant can withdraw the entire amount of their CB if they are leaving their employment. This is because CBs have aspects of both a defined benefit and a defined contribution plan. Typically, participants in a 401k plan have to either wait until retirement to withdraw their funds or draw their benefit in the form of an annuity.
However, since a CB is essentially a hypothetical account, participants are able to easily rollover their entire account balance whenever they need to. The employer, or whoever the plan sponsor is, contributes to this hypothetical account based on a set interest crediting rate…
Another advantage of CBs over 401ks is the reduced longevity and risk associated with the plan. This is especially advantageous for participants who are starting their savings plans later in life. However, CBs also work better if you have a relatively high rate of annual pay. Most CB plan participants make in excess of $250,000 a year.
Although the investment risk is typically lower than a 401k, the risk exposure of a CB plan will also vary widely depending on who is sponsoring the CB. The structure of the CB will also vary depending on the current interest crediting rate and the participant’s cash flow. Alex Pekker and Meghan Elwell of the investment management firm, Sage Advisory Services, recommend a “common-sense” investment strategy via Pensions & Investments. They advise pegging the liability of your investment to the balance of your hypothetical account balance.
Although setting up a CB can be a complicated and laborious process for the plan sponsor, the end product is much easier for the layman to comprehend. With a skillful investment strategy and a capable plan sponsor, cash balance plans can be a superior pension plan option for many employees.