A cash balance pension plan is a type of retirement account considered to be a defined-benefit account. This means that the key determinant of the plan is the benefit rather than the premium. These plans are calculated in reverse when compared to more common pension plans. Contributions are determined by working backwards from the estimated desired retirement income.
Anticipated income upon retirement is calculated by considering salary, employee history and their length of services. The employer then decides upon a retirement income benefit for each individual based upon their calculations. Once these numbers have been defined the employer knows exactly how much needs to be contributed each year to assure the employee of their desired level of retirement income. An actuary is the most qualified individual to run such data.
These types of plans are employer-sponsored, and as such the employee need not make any contributions, although they can opt to do so. Employees may receive their payout as a lump sum or as monthly payments given to the individual or a spouse. Funds may also be placed in an IRA.
The key issue with cash balance pension plans is that they often have lower rates of return than other investments. When the economy suffers a downturn, however, they gain popularity because the payout is not subject to the overall fund performance, the payout is guaranteed. If the fund doesn’t perform according to expectations the company will have to find the missing money elsewhere – often from profits. For the employer the chief benefit is the tax shelter provided for monies placed within the fund.