Rising Rates Allow Cash Balance Plans to De-Risk

Personal FinanceComments

Cash balance plans are gaining popularity as a way for highly compensated individuals to sustain their desired income levels in retirement. But with interest rates on the rise, it may be time to reevaluate how these plans are invested.

Rising Rates Allow Cash Balance Plans to De-RiskSourceMoneyGuru-https://www.mgkx.com/5177.html

Cash balance plans (CBPs) are a type of defined benefit plan that have contribution limits much higher than 401(k)s. This allows high earners, like executives and business owners, to sock away far more than they could in a 401(k) or IRA. But while participants don't direct investments like a 401(k), the plan sponsor must manage investments to try to hit the interest crediting rate (IRC) outlined in the plan document.SourceMoneyGuru-https://www.mgkx.com/5177.html

Many plans aimed for IRCs of 4-5% when rates were near zero. To try to achieve those returns, advisors shifted portfolios heavily toward equities. But with rates rising, those IRCs may now be attainable through more conservative fixed income investments.SourceMoneyGuru-https://www.mgkx.com/5177.html

This creates an opportunity to de-risk CBPs as participants near retirement. Moving from a growth-focused stock portfolio to short-duration, high-quality bonds can provide similar yields with less volatility. This capital preservation approach helps protect participants who are focused on generating dependable income streams in retirement.SourceMoneyGuru-https://www.mgkx.com/5177.html

Of course, advisors must still actively manage duration, credit risk, and diversification. But the core point is that CBPs do not need to take on equity risk solely to achieve typical IRCs in today's environment.SourceMoneyGuru-https://www.mgkx.com/5177.html

The key nuance is that CBPs are focused on consistent annual contributions, not chasing maximum returns. Lower-than-expected returns require greater contributions later to stay on track. But higher returns don't necessarily mean lower future contributions.SourceMoneyGuru-https://www.mgkx.com/5177.html

That's why locking in an IRC-matching yield may make more sense than stretching for speculative gains. This provides predictable contributions and deductions year-to-year, while limiting exposure to market swings.SourceMoneyGuru-https://www.mgkx.com/5177.html

In summary, advisors should reevaluate CBP investment strategies in light of rising rates. While equities may have been necessary to hit IRC targets near zero, high-quality fixed income may now allow hitting those same targets with less risk. De-risking provides stability for participants approaching retirement who want to sustain their standard of living.SourceMoneyGuru-https://www.mgkx.com/5177.html SourceMoneyGuru-https://www.mgkx.com/5177.html




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