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I like to know the difference between a DEFINED-BENEFIT PLAN and a CASH BALANCE PLAN?. Also, what are thw advantages and disadvantages?

Feb 03, 2013 by Edwin from Fresh Meadows, NY in  |  Flag
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Edwin, a Cash Balance plan is a form of Defined Benefit plan. They are both employer funded. However a traditional Defined Benefit Plan will state your benefit as a monthly payment at retirement. A Cash Balance plan will define your benefit as a ‘stated balance’ which you can elect monthly payments at retirement, but you can also take a full distribution. It is similar to a 401(k) for distribution purposes, and is considered by some to be a hybrid between a Defined Benefit plan and a 401(k).

A Defined Benefit plan will typically use a formula for calculating your benefit that includes age, time of service and pay. A Cash Balance plan will determine present value based on pay and time of service, and age to a lesser extent. If the impetus to your question has to do with an employer making a conversion from a Defined Benefit to a Cash Balance plan, if you are an older employee, you may be adversely affected by this change. The employer has some flexibility on formulas used. If you are being adversely affected, take heart in the possibility that if your employer was unable to convert to this less costly plan, the alternative may have been termination of the plan.

Both of these plans use complex actuarial formulas and it is difficult to tell which one will provide a better benefit. There is a tendency for the older employee to get a richer benefit on the Defined Benefit plan. One large advantage to a Cash Balance Plan is you can take your vested money with you as a lump sum. Either way, this is all employer funded, and you win either way.

Please read my Financial Guide What is a Cash Balance Plan for more info on Cash Balance Plans. Also you can review FAQ’s at the United States Department of Labor

http://www.dol.gov/ebsa/FAQs/faq_consumer_cashbalanceplans.html

View all 4 Comments   |  Flag   |  Feb 08, 2013 from Delray Beach, FL
Michael Steven Greenberg, CFP®

The crediting rates are always projected to be low, the objective being to fund a promise by using a reasonably achievable non-volatile benchmark. The crediting rate on a Defined benefit plan will be similar. The actual difference will be that on a traditional DB plan, benefits are determined in part by final average pay; the value of the benefits tend to grow much faster for older workers than for younger workers. On a Cash Balance plan, contributions are made at the same rate , and contributions to a younger employee is actually more valuable because it has more time to compound before retirement. So the traditional DB plan will tend to benefit if he/she is older and has a relatively long time of service. I don't know which plan you will benefit best from. But as an employee, you typically do not have any say as to whether or not a conversion will take place. Without knowing all details, I'd suggest you look at the glass as half-full; that is your employer is giving you a retirement plan. It might not be what you were hoping for or expecting, but your employers alternative might be to freeze or terminate the plan.

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Flag |  Feb 11, 2013 near Delray Beach, FL
Edwin

Thank-you. i am looking at the glass half full.

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Flag |  Feb 11, 2013 near Fresh Meadows, NY

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Peter C. Karp Level 20

Edwin,

In order to answer your question you need to have an understanding of the two plans. The following are the basics of understanding a cash balance plan.

A Cash Balance plan is a defined benefit plan that specifies both the contribution to be credited to each participant and the investment earnings to be credited based on those contributions. Each participant has an account that resembles those in a 401(k) or profit sharing plan. Participant accounts grow annually in two ways:

1) The company contribution – a percentage of pay or a flat dollar amount – determined by a formula specified in the plan document, and;

2) An annual interest credit. The rate of return is guaranteed and is independent of the plan's investment performance. That rate may either be a fixed rate over the life of the plan or may change each year but usually is equal to the yield on 30-year Treasury bonds, which has hovered around 5 percent in recent years. The interest credit is always positive. The interest credit is not related to the actual performance of the Plans assets.

When participants terminate employment, they are eligible to receive the vested portion of their account balance. Cash Balance contributions are age-dependent.

A defined benefit plan will describe all benefits in terms of an annuity payment at retirement and not a lump sum benefit. Although the exact amount of what this is worth today (as a balance) can be estimated, it is never a fixed amount and an actuary will not give you a fixed number that you can hang your hat on.

The fundamental difference is in regard to the participant's understanding of the Plan and what shows on the statements. Simply....a cash balance Plan is a DB plan where the statement can be easily read and understood. Be sure to consult with a qualified retirement plan advisor to determine the best options for your specific situation.

The posted information is for informational purposes only. This message does not constitute an offer to sell or a solicitation of an offer to buy any security. All opinions and estimates constitute Karp Capital's judgment as of the date of the report and are subject to change without notice. Accordingly, no representation or warranty, expressed or otherwise, is made to, and no reliance should be placed on, the fairness, accuracy, completeness or timeliness of the information contained herein. Securities offered through Financial Telesis Inc., member SIPC/FINRA. Financial Telesis Inc. and Karp Capital Management are not affiliated companies.

Comment   |  Flag   |  Feb 05, 2013 from San Francisco, CA

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Jason Hull Level 20

Hi Edwin--

A defined benefit plan provides a specific benefit for an eligible employee at retirement. It's generally what you think of when you hear the term company pension.

A cash balance plan is a type of defined benefit plan. A cash balance plan is one which the plan provides you a certain percentage of return every year, giving you a theoretical cash balance or amount at your retirement.

Alternatively, there are defined contribution plans, such as 401ks and SEPs.

The Department of Labor has a good explanation here: http://www.dol.gov/dol/topic/retirement/typesofplans.htm

If you're going to work for an employer until you retire, then a defined benefit plan is a good thing; you'll have a pension income after you retire, which reduces your income risks in retirement.

If you are going to move from employer to employer, then a defined contribution plan is generally better, as these are portable, and you don't lose the benefits of your contributions as you change jobs.

Of course, this is VERY GENERAL advice. You're best off seeking the counsel of a qualified financial advisor.

Best of luck in your retirement planning!

1 Comment   |  Flag   |  Feb 03, 2013 from Fort Worth, TX
Jason Hull

Michael Greenberg also has a great guide on this topic here at Brightscope: https://www.brightscope.com/financial-planning/advice/guide/5901/What-Is-A-Cash-Balance-Plan/

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Flag |  Feb 08, 2013 near Fort Worth, TX

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