New Pensions May Violate Laws, IRS Says
A controversial type of pension plan being adopted by major U.S. corporations may violate federal age-discrimination laws by cutting retirement benefits for veteran employees, according to a confidential decision by the Internal Revenue Service that was leaked Tuesday.
The decision involves a type of pension, called a cash-balance program, in which companies can reduce their pension costs by cutting future benefits to middle-aged workers--while offering younger workers the benefit of taking a larger cash payout if they leave before retirement.
The decision is a significant development in the growing debate because it provides the first official sign that key regulators are worried about possible abuses associated with the new plans. More than 300 firms have converted to the plans without known strong opposition from federal agencies.
The potential losers in the new programs are workers in their 40s and 50s with 15 or more years of service, whose final pensions are often reduced, according to critics. At IBM, which switched to such a plan in July, dissident workers have argued that employees with 24 years of service could find their pensions reduced by 30% to 50%.
The new pensions have stirred political opposition, but until the IRS decision surfaced Tuesday, it was unclear whether federal agencies had weighed in on the issue. Changes in pension plans must be approved by the IRS, because corporate contributions to pension plans are deductible under tax laws.
A corporate pension plan application was reviewed by the IRS district office in Cincinnati, resulting in a position that the plan violates federal rules because the pension benefit accumulation declines for older workers. The corporation’s name was blacked out in the copy of the document leaked Tuesday, known as a “statement of issue, law and position.”
The IRS had no immediate comment on whether the Cincinnati district memorandum, first issued in September 1998, will become national policy for dealing with the cash-balance pension plans. There is little question that the IRS has approved other cash-accumulation plans in the past.
However, sources said there is considerable discussion and growing concern within the IRS about the topic. Increasing congressional interest also seems likely to spur the IRS to establish a definitive policy on the issue.
The memo was released by Rep. Bernard Sanders (I-Vt.), a vocal critic of cash-balance pensions. The IRS “memo reinforces my strong belief that companies, such as IBM, which are converting to cash-balance plans, may be violating federal age-discrimination laws,” Rep. Sanders said. The law prohibits discrimination against any worker age 40 or over.
The IRS decision could also prompt further age-discrimination lawsuits by older workers against companies converting to cash-balance pensions.
A group of 40 members of Congress, including Sanders, has appealed to the Equal Employment Opportunity Commission, which enforces the antidiscrimination laws, and the Labor Department, to investigate cash-balance pensions. Meetings are scheduled this month with members of Congress and EEOC officials, and future sessions will be scheduled with Labor Department officials.
The issue has developed slowly because of the complexity of pensions, where even experts can get bogged down in a morass of jargon and statistical calculations.
“Companies pay people lots of money to stay ahead of this issue,” said David Sirota, a spokesman for Sanders. “Workers usually don’t know about it--only now are things coming together.”
Under traditional pensions, known as defined-benefit plans, workers who stayed their entire careers with one firm received the maximum benefits. Such workers would receive a guaranteed amount each month in retirement, with the figure linked heavily to a worker’s salary in the final years and the total number of years worked.
In fact, as much as 90% of a worker’s potential benefits may be accrued between the ages of 55 and 65, notes Alan Levit, a consulting actuary in the Los Angeles office of Buck Consultants.
The new trend in pensions is toward defined-contribution plans, such as the popular salary set-aside programs known as 401(k)s. The worker contributes a portion of salary, the company generally matches part of it. The amount available in retirement depends on the success of the investments by the employee.
The new cash-balance programs cosmetically resemble the 401(k) plans. The company contributes to the account, based on the salary, and includes a pledge that the balance will grow by a certain interest rate each year. Any gains beyond the guaranteed rate of return are retained by the company.
“The benefit structure of a cash-balance plan is more in tune with the way that a mobile work force likes to earn their benefits,” says Levit. Younger workers benefit because the money builds up faster than under the traditional defined-benefit plan. If they stay with a firm for five years or more, they generally can take the cash balance with them if they leave for another job. On the other hand, cash-balance plans don’t give older workers any incentive to hang on until retirement age before leaving their jobs.
But older workers are entering a stage of life when they would normally get an accelerated buildup of money under the old pension plan. Instead they are switched to the cash-balance program, where they get a much smaller accumulation. In some plans, the buildup is frozen for years.
Some firms have avoided criticism by giving all veteran workers the choice of going into the new program or remaining in the old plan. The new plans have proved popular among large employers in Southern California and elsewhere, said Laura Tarbox, a Newport Beach certified financial planner and employee benefits specialist. “Most of the major employers in the Fortune 100 have switched or are at least considering it,” Tarbox said.
Tarbox’s husband, a human resources specialist, benefited from Edison International’s decision to switch from a traditional defined-benefit plan to a cash-balance plan this year.
John Wallin, 43, left Edison this spring after two years to work for a recruiting firm. The cash-balance plan paid him about $8,000. “The old plan at Edison required you to be there five years or you got nada,” Wallin said. “I was delighted when they converted it.”
Edison grandfathered-in older workers, allowing them to choose between the old plan and the new.
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Times staff writers Liz Pulliam and Paul J. Lim contributed to this report.
