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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.
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