# Cash Balance Pension Plan: Overview, Pros and Cons

![Cash Balance Pension Plan: A defined-benefit pension plan that gives participants a set percentage of their yearly compensation plus interest charges.](https://www.investopedia.com/thmb/TJxKgIEGeEH9skXiPbPEnY5nYek=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/CashBalancePensionPlan-final-9319eb9ddc5f425bb0d2b04a0f03f778.png)

*— Investopedia / Zoe Hansen*

## What Is a Cash Balance Pension Plan?

A cash balance pension plan is a [defined-benefit](https://www.investopedia.com/terms/d/definedbenefitpensionplan.asp) pension plan with the option of a lifetime annuity. The employer credits a participant's account with a set percentage of their yearly compensation plus interest charges for a cash balance plan. The funding limits, funding requirements, and investment [risk](https://www.investopedia.com/terms/r/risk.asp) are based on defined-benefit requirements. Changes in the portfolio do not affect the final benefits received by the participant upon retirement or termination, and the company bears all ownership of profits and losses in the portfolio.

### Key Takeaways

*   A cash balance pension plan is one in which participants receive a set percentage of their yearly compensation plus interest charges.
*   This type of plan is maintained on an individual account basis, much like a defined-contribution plan.
*   Cash balance pension plans do not have contribution limits because the employer funds them to meet a specific account balance at an employee's planned retirement date.

## Understanding Cash Balance Pension Plans

A cash balance plan (CBP) is maintained on an individual account basis, much like a [defined-contribution plan](https://www.investopedia.com/terms/d/definedcontributionplan.asp). The features of cash balance pension plans resemble those of [401(k)](https://www.investopedia.com/terms/1/401kplan.asp) plans. Investments are managed professionally, and participants are promised a specific benefit at retirement. However, the [benefits are stated](https://www.investopedia.com/the-little-known-retirement-plan-the-wealthy-swear-by-11701012) in terms of a 401(k)-style account balance rather than in terms of a monthly income stream.

For instance, an employee on a cash balance pension plan might receive a promise of 5% of their salary with a 5% interest credit. If they made $100,000 annually, they would receive a pay credit of $5,000 plus 5% interest paid on the account balance. As the number of years at the employer increases, the account balance grows to meet the balance promised by the company. At retirement, the employee can choose a [lump-sum payment](https://www.investopedia.com/terms/l/lump-sum-payment.asp) or a monthly [annuity](https://www.investopedia.com/ask/answers/12/what-is-an-annuity.asp) payment.

> **Important**
>
> The benefits of private-sector pension plans are protected by federal laws, such as the Employee Retirement Income Security Act (ERISA).

## Cash Balance Pension Plan vs. Traditional Pension Plan

The most significant difference between a cash balance pension and a [traditional pension plan](https://www.investopedia.com/terms/p/pensionplan.asp) is that the traditional plan generally uses a few years of your highest compensation to determine your monthly benefit. A cash benefit pension plan uses the total number of years you've been with the company.

## Cash Balance Pension Plan vs. 401(k)

The most significant difference between a cash balance pension and a 401(k) is that the employer bears the investment risk in a CBP. The employer is responsible for ensuring the employee receives the amount promised, so no matter what happens, it must ensure the employee gets that amount. With a 401(k), the employee bears the investment risk because they choose the way the plan invests. The employer has no investment risk. Additionally, the retirement benefit amount depends on the balance of the account; it isn't guaranteed, as it is with a cash balance pension.

The other difference is the [contribution limit](https://www.investopedia.com/terms/y/years-maximum-pensionable-earnings.asp). People 60 years or older can sock away significantly more annually in [pretax contributions](https://www.investopedia.com/terms/p/pretaxcontribution.asp).  

## Pros and Cons of a Cash Balance Pension Plan

While this type of plan does have several benefits, there are some disadvantages to consider, as well.

Pros

*   Lump sum payouts
    
*   Rollover options
    
*   Tax-deferred
    
*   Custom contribution limit
    

Cons

*   Taxable distributions
    
*   High cost to maintain
    
*   No employee contributions
    

### Pros Explained

*   **Lump Sum Payouts**: A cash balance pension [payout](https://www.investopedia.com/terms/p/payout.asp) can be made as a lump sum. This can benefit someone who wants to place the capital in a traditional preservation instrument like government [bonds](https://www.investopedia.com/terms/b/bond.asp) or [money market funds](https://www.investopedia.com/terms/m/money-marketfund.asp).
*   **Rollover Options**: You can roll a lump sum payout into an IRA or another pension plan.
*   **Tax-Deferred**: Contributions are [tax-deferred](https://www.investopedia.com/terms/t/taxdeferred.asp). This means you don't pay taxes on the funds until you make withdrawals or take a lump sum payment. If you're in a higher tax bracket when you're contributing than when you make withdrawals, you pay less in income tax.
*   **Custom Contribution Limit**: The annual limit for a cash balance pension depends on how much you make, how old you are, and the target date and balance of the fund. [Individual retirement accounts (IRAs)](https://www.investopedia.com/terms/i/ira.asp) and 401(k)s have annual limits set by the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp).  
    

### Cons Explained

*   **Taxable Distributions**: While the tax-deferred treatment is a benefit, you will have to pay taxes when you withdraw money.  
    
*   **High Costs to Maintain**: The costs to maintain the plans are higher because an actuary is needed to ensure they perform well enough to meet the balance requirements. This translates into higher costs for employers.
*   **No Employee Contributions**: Only the employer contributes, so you can't add capital from your wages.  
    

## Special Considerations

When combined with a 401(k) plan, cash balance employer contributions for rank-and-file employees usually amount to a slightly higher percentage of pay when compared with just a typical 401(k) plan.

Participants receive an annual interest credit. This credit may be set at a fixed rate, such as 5%, or a variable rate, such as the [30-year Treasury](https://www.investopedia.com/terms/1/30-yeartreasury.asp) rate. At retirement, participants can take an annuity based on their account balance or a lump sum, which can then be [rolled into an IRA](https://www.investopedia.com/terms/i/ira-rollover.asp) or another employer's plan.

Cash balance pension plans are often more expensive to administer than traditional employer-sponsored [retirement savings plans](https://www.investopedia.com/terms/r/retirement-planning.asp) like the 401(k). That's because these pension plans require certification to ensure they're adequately funded. The types of fees and amounts for each can vary, but cash plans tend to have higher startup costs, annual administration charges, and relatively high [management fees](https://www.investopedia.com/terms/m/managementfee.asp).

## Is a Cash Balance Pension Plan Better Than a 401(k)?

Both can be excellent retirement plans. Which one is better depends on your preferences, goals, how long you might be with an employer, and your current income.

## What Can I Do With a Cash Balance Plan?

You can choose to make withdrawals or a lump sum payout. If you choose a lump sum, you can roll it into an IRA or other retirement plan if allowed.

## What Happens to My Cash Balance Pension If I Quit?

Your cash balance pension is portable, so you can take the [vested](https://www.investopedia.com/terms/f/fully-vested.asp) portion with you when you part ways with the company and roll it into another retirement account.

## The Bottom Line

A cash balance pension plan is similar to other retirement accounts. The contributions are tax-deferred for the employee, and the principal grows with [compounding interest](https://www.investopedia.com/terms/c/compounding.asp) and capital [gains](https://www.investopedia.com/terms/g/gain.asp). The employer takes on all of the investment risk. The employee can use their wages to invest in another retirement fund of their choice.

While a cash balance pension is an excellent retirement plan option, you should choose one with caution. Compare the tax treatment you expect to receive when you retire to see if it or another plan would work better for your financial situation.

> **Article Sources**
>
> 1.  U.S. Department of Labor. "[Cash Balance Pension Plans](https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/faqs/cash-balance-pension-plans-consumer.pdf)," Page 1.
>     
> 2.  U.S. Department of Labor. "[Cash Balance Pension Plans](https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/faqs/cash-balance-pension-plans-consumer.pdf)," Page 2.
>     
> 3.  U.S. Department of Labor. "[Fact Sheet: Cash Balance Pension Plans](https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/fact-sheets/cash-balance-pension-plans)."
>     
> 4.  Kravitz. "[2018 National Cash Balance Research Report](https://www.cashbalancedesign.com/wp-content/uploads/2018/08/NationalCashBalanceResearchReport2018.pdf)," Page 7.