Got a Cash Balance Pension? Understand Your Options
To maximize your retirement income, you need to know how your cash balance plan works, which type of payout is right for you and how it’s taxed.
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.
From just $107.88 $24.99 for Kiplinger Personal Finance
Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
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.
Related Content
- Five Things Your Annuity Seller Won’t Tell You
- A Public Pension and Full Social Security Benefits? No Way
- Social Security Basics: 12 Things You Must Know to Maximize Your Social Security Benefits
- Pension Lump Sum Option vs. Annuity Payment: Which Is Better?
- Before You Retire, Consider These Five Questions
-
The Rule of Compounding: Why Time Is an Investor's Best FriendDescribed as both a "miracle" and a "wonder," compound interest is simply a function of time.
-
4 Great Tools to DIY Your Own Financial PlanSmart Savings Several tools picked out by Kiplinger that DIYers can use to make their own financial plan.
-
The 7-Month Deadline That Sets Your Lifetime Medicare PremiumsUnderstanding Medicare enrollment is crucial, as missing deadlines can lead to permanent late enrollment penalties and gaps in coverage.
-
If You're a U.S. Retiree Living in Portugal, Your Tax Plan Needs a Post-NHR Strategy ASAPWhen your 10-year Non-Habitual Resident tax break ends, you could see your tax rate soar. Take steps to plan for this change well before the NHR window closes.
-
Could Target-Date Funds With Built-In Income Guarantees Be the Next Evolution in Retirement Planning?With target-date funds falling short on income certainty, retirement plans should integrate guaranteed income solutions. Here is what participants can do.
-
Your Year-End Tax and Estate Planning Review Just Got UrgentChanging tax rules and falling interest rates mean financial planning is more important than ever as 2025 ends. There's still time to make these five key moves.
-
What Makes This Business So Successful? We Find Out From the Founder's KidsThe children of Morgan Clayton share how their father's wisdom, life experience and caring nature have turned their family business into a respected powerhouse.
-
Past Performance Is Not Indicative of Your Financial Adviser's ExpertiseMany people find a financial adviser by searching online or asking for referrals from friends or family. This can actually end up costing you big-time.
-
I'm a Financial Planner: If You're Not Doing Roth Conversions, You Need to Read ThisRoth conversions and other Roth strategies can be complex, but don't dismiss these tax planning tools outright. They could really work for you and your heirs.
-
Could Traditional Retirement Expectations Be Killing Us? A Retirement Psychologist Makes the CaseA retirement psychologist makes the case: A fulfilling retirement begins with a blueprint for living, rather than simply the accumulation of a large nest egg.
-
I'm a Financial Adviser: This Is How You Can Adapt to Social Security UncertaintyRather than letting the unknowns make you anxious, focus on building a flexible income strategy that can adapt to possible future Social Security changes.
