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Cash balance retirement plans: Annuity options

If you're retiring from a company with a cash balance retirement plan, take the time to analyze your payout options. While many people take a lump sum payout, the annuity option might be best for you. Let's take a look to see why.

Cash balance defined benefit plans are offered by many large employers; according to a recent survey by Towers Watson, 25 percent of the Fortune 100 offer these retirement plans to their employees. A cash balance plan is a hybrid retirement plan that shares some features of both a traditional pension plan and a 401(k) plan.
Here's how they work:

- Like a 401(k) plan, your benefit is an account that grows with contribution and interest credits. Usually you can take the full amount in your account with you when you terminate or retire.

- Like a pension plan, your employer takes any investment risk; before you retire, your account always earns the interest crediting rate that's specified in the plan, even if the assets in the pension trust tank due to a market downturn.

- As with a pension plan, at retirement, you have the option to have the plan pay you a monthly retirement income -- a.k.a. an annuity -- for the rest of your life, or take the money and roll it over to another type of income-generating account.

So when you retire, should you take your account and roll it over to another type of account that could generate a monthly income for you, such as an IRA or annuity, or should you elect to have the plan pay you the monthly annuity? One way to come up with the best answer to this question is to compare the monthly income you would get from your employer's cash balance plan to the annuity income you'd get if you took the lump sum payout and bought an annuity from an insurance company.

IRS rules specify the minimum requirements for converting cash balance accounts to an annuity; these minimum conversion rates are usually more favorable to you than the annuity purchase rates you could get if you buy the annuity on your own. And some employers go beyond the minimum requirements and offer even better deals on the annuity.

The graph below compares the minimum amount of annual annuity income for a 65-year-old man or woman who retires in 2012 with $100,000 in a cash balance plan to the retirement income they could purchase if they buy an annuity on their own from an insurance company. All of these amounts are for fixed, single-life monthly annuities where the amount of income doesn't change over your lifetime.

Note that a cash balance plan pays the same amount for a man or a woman, due to federal laws that prohibit sex discrimination in employer-sponsored plans. On the other hand, an insurance company is allowed to pay a smaller retirement income to a woman because they expect a woman to live longer than a man. In the above example, a single man receives an annual retirement income from the cash balance plan that's $920 higher than the annuity from an insurance company. The difference for a woman is even greater; she can realize an annual income that's $1,470 higher from the cash balance plan.

You'll see similar differences for people who retire at ages other than age 65, and for joint and survivor annuities for couples.

The amounts shown above for an annuity from an insurance company come from Vanguard's Annuity Access program in January, 2012, as shown in my recent post, Retirement income scorecard first quarter 2012: immediate annuities.

To help you make the best decisions for your retirement, this post compared annuity income from a cash balance plan to annuity income from an insurance company. But is a lump sum a better choice? The short answer is, if you're in average or above average health and you're worried about stock market crashes impacting your retirement income, the annuity might be the better choice. It pays you a lifetime monthly income, no matter how long you live and no matter what happens in the economy. You can see details on the pros and cons of this decision in my recent posts shown below.

Pension plan lump sum payments: Why you should avoid them
Pension plan lump sum payments: Arguments for taking them

By the way, the conclusions are the same for other hybrid retirement plans where your benefit is defined as an account, such as a pension equity plan.

For many of you, your cash balance account is one of your largest retirement assets, so it's well worth spending a little time analyzing which option will produce the retirement income that best meets your needs.

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