Some call them the last, best hope for saving defined-benefit pensions. This year, however, cash-balance plans are at a legal and legislative crossroads that could determine the future of employer-provided retirement benefits, say plan advisers.
The case in favor of cash-balance plans is, in part, a case against 401(k)s. Verizon, Rockwell Collins, and other members of the growing ranks of employers that are freezing their pension plans are making up some of the difference to their workers by increasing their contributions to employee 401(k)s. Critics maintain, however, that the substitution shortchanges retirees.
Enter the cash-balance plan, a “hybrid” that’s re-emerging as a middle ground between defined-benefit and defined-contribution plans. Legally it’s a DB plan (the employer, not the employee, takes on the financial risk of achieving a preset benefit), but it’s structured like a DC plan (somewhat like a 401(k), it features a stated account balance). Compared with traditional pension plans, cash-balance plans can provide employers with more funding flexibility while often demanding lower payouts. “Everybody sees cash-balance plans as the future of defined-benefit plans,” said Rhonda Migdail, director of employee-benefits research at actuarial consultancy Milliman, during a recent pension seminar.
One problem: When employers switch from a traditional plan to a cash-balance plan, older employees lose more than do their younger colleagues. To be sure, workers of all ages are more likely to lose rather than gain benefits when their employer makes the switch, according to results of Government Accountability Office simulations issued last October. But among those workers who encounter cutbacks, the size of the median benefit decrease was definitely age-linked: Cuts ranged from $59 a month at age 30 to $238 a month at age 50.
Under the Employee Retirement Income Security Act, distributions like that won’t wash. As a result, of the 133 conversions studied by the GAO, 47 percent grandfathered benefits from the former plan to at least some older workers. Even so, a flood of conversions to cash-balance plans between 1990 and 1999 has turned into a trickle.
A big reason is the negative reception that such conversions have received in the courts. In the best-known case, last year IBM settled charges of age discrimination that involved its benefit plans in the mid-1990s; the company is committed to paying out $315 million and will pay $1.4 billion more if it loses on appeal. And earlier this month, a federal judge in Bridgeport, Connecticut, ruled that a former Fleet Bank employee can move ahead with a lawsuit alleging that the company discriminated against older workers when it switched to a cash-balance plan.
Adding to employers’ uncertainty: Congress continues to debate a pension-reform bill that likely will revise cash-balance regulations. The House recently approved a motion to accept Senate provisions for new mandates governing employers that convert to a hybrid plan; employers have opposed the provisions, according to Hewitt Associates.
If unfavorable legislation is signed into law or a major court decision turns out badly for employers, cash-balance plans could face a wave of shutdowns this year, says John Ehrhardt, a consulting actuary with Milliman. But if the outcomes are favorable, he adds, “you may see a rush of conversions” from defined-benefit to cash-balance plans.