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The Trend That Could Save Your Retirement

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For years, the prospects for employer-sponsored retirement plans have continually grown worse. With companies eliminating pension plans and cutting back on matching contributions to 401(k) accounts, employers appeared to want to opt out entirely from helping their workers prepare for their retirement years.

But even amid the worst recession in decades, there's a glimmer of hope for workers. A small group of companies has pushed back against the trend of more modest retirement support, instead expanding their workers' opportunities to provide for themselves during their golden years.

Going beyond 401(k)s
In general, employers have moved away from traditional pension plans in favor of defined contribution plans like 401(k)s, where the employee must decide how much to save and how to invest. But one type of defined benefit plan, known as the cash balance plan, has gained growing popularity among employers wanting to do more for their workers. Since 2006, employers including SunTrust Banks (NYSE: STI  ) , MeadWestvaco (NYSE: MWV  ) , and Dow Chemical (NYSE: DOW  ) have established cash balance plans for their employees.

Last week, Coca-Cola (NYSE: KO  ) became the latest to offer this type of pension plan. In order to understand the ramifications of the move, let's take a closer look at Coke's plan provisions to see how cash balance plans work.

What are cash balance plans?
Cash balance plans look different from traditional pensions. Under most pension plans, workers accumulate a fixed monthly benefit, based on a formula that includes factors like your salary and the number of years you've worked for the company. With these formula-based pension plans, there's no apparent connection between your benefit and the money that the company sets aside to pay it. Indeed, benefits can grow extremely quickly during your last few years of work, since many pensions reward career longevity.

Cash balance plans, on the other hand, don't promise a fixed monthly benefit after you retire. Instead, they guarantee you a certain lump sum. For instance, the Coke plan contributes 3% of salary for every year an employee works for the company. The employee is also credited with interest on that contribution over the years. When employees retire -- or in some cases, leave to go to another company -- they're entitled to that lump sum, either as a distribution or to roll over into their own IRA account.

From the worker's standpoint, cash balance plans have their pros and cons. Since they represent free employer money, they're definitely better than nothing.

On the other hand, by guaranteeing only a lump sum rather than a monthly benefit for life, cash balance plans have some of the same flaws as 401(k) plans. You still have to figure out how you'll convert that lump sum into income at retirement. And although the employer has to figure out how to come up with the money to pay your benefit, it's far easier for employers to figure out their eventual liability under cash balance plans than with traditional pension plans.

Not all positive
Of course, whether cash balance plans are good depends on what employees had before. At FedEx (NYSE: FDX  ) , for example, a regular pension plan was discontinued in favor of a cash balance plan, which arguably made some workers worse off. In substance, it's similar to measures that Verizon (NYSE: VZ  ) and DuPont (NYSE: DD  ) took when they froze their pensions, instead adding to their 401(k) matching programs. The matches look nice by themselves, but not as good when considering what was replaced.

All told, though, cash balance plans at least represent employers' continuing obligation toward their workers. In addition, their greater ease of portability from job to job makes them attractive to younger workers, who will never spend the decades necessary at one job to build up huge pension benefits. If this trend continues, it could go a long way to helping you save your retirement.

More on protecting your retirement:

The world of pensions is complicated. Need help understanding your retirement savings options? Get it from The Motley Fool's Rule Your Retirement newsletter. You'll find the answers you need with a free 30-day trial.

Fool contributor Dan Caplinger hopes more companies will recognize the value of their workers. He doesn't own shares of the companies mentioned in this article. Coca-Cola is a Motley Fool Inside Value recommendation. FedEx is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy is trending toward your best interest.


Read/Post Comments (1) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 27, 2009, at 11:33 AM, RaymondBerry wrote:

    Good article highlighting cash balance plans.

    However, the comment that cash balance plans "don't promise a fixed monthly benefit after you retire" is a little misleading. A cash balance plan is a defined benefit plan for which the automatic form of benefit at retirement is a single life annuity (or 50% contingent life annuity if married). Almost all cash balance plans allow a participant to elect the lump sum payment in lieu of the life annuity. The lump sum option is also very common among traditional defined benfit plans. Even in a cash balance plan the participant can choose the life annuity instead of the lump sum.

    I share the authors concern about the general popularity of the lump sum option. One of the significant risks for a retiree is longevity. The retiree does not know how long they will live. "You can't out live an annuity payable for life"

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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