Pay Attention If You’re Considering Conversion to Cash Balance

Is your organization among the growing number of those considering conversion of a traditional defined benefit pension plan to a cash balance pension plan? If so, be advised that political pressures against these plans continue to build.

Agencies increase scrutiny.
Increasing concern about the fairness of cash balance plans has prompted both the Internal Revenue Service (IRS) and the Equal Employment Opportunity Commission (EEOC) to take a closer look at whether such plans violate tax and age discrimination laws. Several bills are pending in Congress to regulate cash balance plans, and both sides of the controversy expressed their views at a September 21 hearing before the Senate Health, Education, Labor and Pensions Committee.

IRS: Specific cash balance plans may fail to qualify.
The IRS instructed division chiefs on September 15 to request technical advice for any open determination or examination cases regarding the effect on the plan’s qualified status of conversion of a traditional defined benefit plan formula to a cash balance formula. To date, the IRS has made no specific statements indicating that cash balance plans as a whole violate the law. However, in at least two cases the IRS has expressed the view that specific cash balance plans may fail to qualify for tax purposes.

EEOC: Do cash balance plans result in age bias?
Meanwhile EEOC’s Ida L. Castro announced on September 20 the creation of a national EEOC team of experts to focus on the legality of employer conversions to cash balance pension plans. “Whether or not cash-balance pension plans discriminate against employees covered by the Age Discrimination in Employment Act (ADEA) is a question that I am determined to explore fully,” said Ms. Castro.

Why the concern?
The crux of the debate is whether older workers, who are closer to retirement, are unlawfully discriminated against when employers convert from traditional defined benefit pension plans to cash balance pension plans. Experts estimate that in a conversion an employee who is five to ten years away from retirement may lose 20 to 50 percent of the expected age 65 benefit.

This is because traditional defined benefit plans calculate an employee’s benefits by using the number of years of an employee’s service and the employee’s final average pay, giving workers a dramatic increase in the value of their benefits as they near retirement. But cash balance plans offer a more constant rate of return, making them attractive to younger, more mobile workers. In a conversion, some workers may experience “wear away” and receive no benefits for a number of years.

Industry association defends cash balance plans.
The ERISA Industry Committee (ERIC), a trade association representing large employers, says that cash balance plans don’t violate the ADEA just because benefits accrue more rapidly in a cash balance plan during an employee’s initial years of employment.

This “frontloading” of benefits is due to IRS rulings, they say, and not an intent to discriminate on the basis of age. They stress that each individual in a cash balance plan receives the same percentage of compensation pay credit (except for those plans that provide higher credits to older workers) and that the rate at which interest credits are calculated also is uniform.

“It’s interesting that for many years traditional final average pay defined benefit plans have been criticized for concentrating benefits among those employees who were able to remain with one employer for their entire working careers,” said ERIC President Mark Ugoretz.

What’s the solution?
One answer is to allow employees who are five to ten years away from retirement to receive the greater of what he or she will receive under the new cash balance plan or what he or she would have received under the traditional defined benefit plan.

Other ways to ease the effects of a conversion include enhancing the opening account balance of employees who are five to ten years away from retirement, or enhancing the annual pay credits or interest credits of those employees.

Legislative proposals.
Congress is also looking for solutions. Rep. Bernard Sanders (Ind-Vt) and Sen. Tom Harkin (D-Iowa) have both sponsored bills that would forbid wear away. The Sanders bill would also required increased disclosure and impose potentially heavy penalties on companies that do not allow their employees to remain in the old plan upon converting to a cash balance plan. The Clinton administration supports increased disclosure; it would require companies with 100 or more employees to notify their employees of plan changes and, upon request, provide details about how benefits will change.

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