Cash balance plans, a hybrid of traditional defined benefit pension plans and defined contribution 401(k) plans, lately seem to offer more risks than benefits — among them, increased funding obligations, a damaging court ruling on age discrimination, and pending Congressional action to curb conversions from traditional pension plans.
Last week, lawmakers in the House and Senate decided to bar the Bush administration from finalizing its proposed pension rules on cash balance plans — through the Department of the Treasury — in hopes of limiting the number of conversions to the hybrid plans, which many consider detrimental to older worker’s retirement savings. The reconciliation was part of the annual spending bill that funds the Treasury Department.
According to Reuters, legislators also required that the Treasury offer legislation within 180 days on how best to convert traditional pension plans to cash balance plans. The compromise bill is expected to be voted on early next week.
Still, plan sponsors continue to fret over a ruling earlier this year by a federal judge, who found that IBM’s cash balance and pension equity formulas discriminated against older workers, in violation of the Employee Retirement and Income Securities Act. If the decision is upheld next year on appeal, many experts believe it would render all cash balance plans illegal.
Chuck Longiotti, retirement practice leader at Mercer Consulting, says a resolution of the age discrimination issue can’t come too soon. “The longer that we don’t have clarification,” says Longiotti, “the more employers are going to stop taking the risk” — that is, the more likely they’ll be to freeze their cash balance plans.
Hundreds of major companies have been drawn to these hybrid plans as an effective recruitment and retention tool. Cash balance plans account for 25 percent of all participants in defined benefit plans and 40 percent of all assets invested in defined benefit plans, according to Federal Reserve Board data, cited by IBM in a recent press release. Last year benefits consultancy Watson Wyatt Worldwide found that 33 of the largest 100 corporations have instituted such plans.
In a cash balance plan, retirees have the security of a guaranteed monthly pension, a more easily understood individual “account balance,” and the portability of a 401(k). And since the plan sponsor makes contributions that are evenly spread out over an employee’s time with the company, employers often enjoy greater cash flow predictability, funding options, and in some cases, cost savings.
The Little Difference That Makes All the Difference
However, that distinction from a traditional defined benefit plan, in which employees receive a greater credit to their “account” in their final years of service, is at the heart of the IBM debate. When a company converts to a cash balance plan, younger workers have more years to accrue interest on those contributions than older workers do — thus raising the issue of age discrimination.
Lynn Dudley, vice president and general counsel at the American Benefits Council, a Washington, D.C., lobbying group, says companies are increasingly likely to freeze their plans and convert to a 401(k) amid the legal uncertainty. “I would never recommend to a client to adopt a cash balance plan before that [age discrimination] issue works its way through the judicial system,” she says. “You expose yourself to a lot of litigation.”