Got a Cash Balance Pension? Understand Your Options

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As traditional pension plans have largely disappeared over the years, many Baby Boomers heading into retirement today will by relying on cash balance pension plans instead. Understanding how to make the most of this employer benefit becomes increasingly important as one nears retirement.

Cash balance pension plans became popular in the late 1980s and early 1990s, especially with companies such as IBM, Xerox and AT&T, which at the time had large liabilities in their traditional defined benefit pensions. Cash balance pension plans emerged as a hybrid between traditional defined benefit plans (aka, a pension) and defined contribution plans (such as a 401(k) plan), offering employees a portable retirement benefit. The plans gained popularity among employers seeking to manage their costs and risks, while providing competitive retirement benefits.

Individuals with a cash balance pension plan face numerous decisions as they near retirement. Understanding the various options available is crucial for maximizing retirement income and ensuring financial security.

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Let’s review the considerations and choices one should explore when navigating their cash balance pension options.

The basics

Unlike traditional defined benefit pensions, which provide a specific monthly benefit upon retirement, a cash balance pension maintains a hypothetical account balance that grows based on company contributions and interest credits. Unlike a 401(k), the employee can’t select a menu of investment options from which to invest their balance. The company determines the cash balance plan’s crediting rate, sometimes quarterly, but most often set annually. Here are a few companies’ cash balance pension plans’ crediting rates for 2024:

GlaxoSmithKline: 3%
Duke Energy: 4.46%
IBM: 5%

Upon retirement or separation from service, employees typically have several distribution options.

Option 1: A lump sum payment in cash.

Cash balance participants may consider taking a lump sum payment from their cash balance pension. However, the entire payment is taxed as ordinary income, which can be very costly. Participants should carefully weigh the tax implications associated with a lump sum distribution.

Option 2: An IRA rollover.

Participants can roll over their cash balance pension to an IRA. A direct rollover to a qualified retirement account is not taxable — but any withdrawals you take later on will be taxed. An IRA rollover offers a couple of major advantages: It provides the participant with greater investment options, and it allows for more flexible income tax planning.

Keep in mind that if you leave a company before retirement, some companies don’t allow a rollover until the participant reaches a specified age. In addition, some employers require those with small cash balance pension benefits (say under $10,000) to exit the plan — either in lump sum or IRA rollover — when separating from service.

Option 3: Annuity payments.

Another option is to convert the cash balance pension into a series of annuity payments. Annuities provide a steady stream of income over a specified period, offering retirees a predictable source of retirement income. Retirees should compare different annuity providers and payment options to find the most suitable arrangement for their financial needs and goals.

Participants can also opt for some combination of these different options. For example, a participant might decide to take annuity payments for 50% of their cash balance pension and do an IRA rollover with the other 50%.

Other considerations

As interest rates have risen, the crediting rates of some cash balance pension plans are lower than CD rates, making the rollover option more attractive. Participants should also remember that cash balance pension plans are subject to the same required distribution rules as IRAs.

Cash balance pension plans are an often-overlooked component of one’s retirement nest egg. Navigating retirement options with a cash balance pension requires careful consideration and planning. By understanding the available options, evaluating individual goals and managing cash balance pensions in concert with 401(k) and Social Security benefits, retirees can pave the way for a secure and fulfilling retirement journey.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Mike Palmer has over 25 years of experience helping successful people make smart decisions about money. He is a graduate of the University of North Carolina at Chapel Hill and is a CERTIFIED FINANCIAL PLANNER™ professional. Mr. Palmer is a member of several professional organizations, including the National Association of Personal Financial Advisors (NAPFA) and past member of the TIAA-CREF Board of Advisors.