Cash Balance Plans Still OK, But Stay Tuned ..

Cash balance plans have recently become a hot topic in the press. Critics say that such plans violate pension law by taking away benefits from older workers. This view appeared to receive some support recently with the release of a confidential memo in which the director of an Internal Revenue Service key district office indicated that a cash balance plan may be in violation of the law.

What is a cash balance plan?
Traditional pension plans calculate an employee’s benefits by using the number of years of an employee’s service and the employee’s final average pay. Thus, most of the benefits build up at the end of an employee’s career. Under cash balance plans, an employee’s benefits grow at a steady pace. Thus, such plans offer better benefits to younger, more mobile workers, but offer less, often substantially less, benefits to older workers with many years at one company. Employers can save money by converting traditional pension plans to cash balance plans, and many of them have been doing so.

What does Congress say?
Cash balance plans are the subject of legislative proposals in Congress. One proposal would require such plans to comply with more stringent notice requirements to participants affected by a conversion of a traditional pension plan to a cash balance plan. Some members of Congress have gone further, urging a ban on new cash balance plans. Recently, a congressional opponent of cash balance plans, Rep. Bernard Sanders of Vermont, leaked a confidential IRS memo written in 1998 in which the director of the IRS key district office in Cincinnati expressed the view that a cash balance plan may fail to qualify for tax purposes because the plan’s benefit accruals decrease as a participant ages.

What is the IRS position?
The release of the memo was picked up by the major media and fueled speculation that the IRS was now weighing in against all cash balance plans. However, the IRS has said that the memo was a request from the field office for technical advice from the IRS National Office regarding a specific case and does not reflect the general position of the IRS. In a related matter, the IRS recently took a formal position against a cash balance plan in pending litigation before the U.S. Tax Court and cited grounds for disqualifying the plan. However, this cash balance plan is viewed as “atypical” and not representative of the majority of these types of plans.

The bottom line.
To date, the IRS has made no specific statements indicating that cash balance plans as a whole violate the law. The memo and case referred to above involve specific and unique fact situations. Pending a change in the law coming from Congress or general guidance from the IRS, cash balance plans are likely to continue.

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