Opening Door to Cash-Balance Pensions
The Treasury Department proposed rules Tuesday that would end a three-year moratorium on conversions to a complicated and controversial type of pension that has been criticized for depriving older workers of promised benefits.
The new rules are aimed at clarifying whether converting traditional pensions to so-called cash-balance plans discriminates against older workers. As proposed, the rules would slightly modify though largely allow many practices that have made the plans controversial, pension experts and others said.
“The immediate impact of these rules, if they go into effect, will be to substantially slash the pensions of older workers throughout the country,” said Rep. Bernie Sanders (I-Vt.). “Millions of workers will see a reduction in the pensions that they anticipated. This will be a disaster for them and their families.”
Meanwhile, employer groups heralded the proposed rules, which must be approved by the Internal Revenue Service after a public comment period. Companies maintain that the rules would make pensions less costly and more widely available.
What are cash-balance plans? What do the new rules allow? Whom would they cover? Here are some answers.
Question: What’s a cash-balance pension?
Answer: It’s a type of defined-benefit pension plan -- that’s the traditional pension, which promises a set monthly benefit for life. Under traditional formulas, pension benefits are calculated as a percentage of wages multiplied by years of service. A typical formula might provide 1.5% of final monthly wages, times years of service, for example. Consequently, a 20-year employee would get 30% of his final salary in monthly benefits at age 65. All the money contributed to the plan comes from the employer.
With a cash-balance plan, the employer also makes all pension contributions. But the worker’s pension benefit, which can be paid in a lump sum or a monthly stipend, depends on how much the employer contributes every year and the rate of return earned on the account -- much like a 401(k). Such a plan also is portable, allowing workers to cart their pensions from one employer to another.
Q: What makes the plan so controversial?
A: About 700 major corporations “converted” their traditional pensions to cash-balance plans over the last decade. Experts maintain that the bulk of these conversions drastically reduced future benefits for millions of workers. Rep. George Miller (D-Martinez), estimates that about 8 million current and retired workers have lost $334 billion in promised benefits as a result of conversions.
Hardest hit are usually the oldest employees, who can no longer count on receiving their promised benefits and are too old to save enough on their own to make up the difference, said Karen Ferguson, director of the Pension Rights Center in Washington.
Federal law bars firms from taking away pension benefits that workers already have earned. However, cash-balance plan conversions often would stop the continued accrual of pension benefits for older workers. In other words, a worker would get a benefit equal to the present value of his or her future pension at age 50 but then work 15 more years without any additional pension benefit. Younger workers, meanwhile, would continue to accrue benefits.
Dozens of workers have sued, claiming the conversions are discriminatory. The IRS, which determines whether pensions qualify for tax-favored treatment, stopped approving cash-balance plan conversions in late 1999 because of the possible conflict with federal prohibitions on age discrimination.
The proposed rules clarify the Bush administration’s take on the law and would end the moratorium.
Q: What would the proposed rules do?
A: They would interpret pension law in such a way that cash-balance plan conversions would not be in violation of age discrimination rules, as long as they met certain requirements.
Specifically, a plan must give each participant the fair present value of the existing pension benefit at the time of conversion or the cash-balance amount, whichever is greater. However, if at the time of conversion the value of the old defined-benefit plan is greater than the amount the worker would be due under the cash-balance formula, the employee could go a period of time, in some cases years, without earning any new benefits. This so-called wearaway period is not age discriminatory on its face, according to the proposed rules.
Q: When would these rules go into effect?
A: They are subject to a 90-day comment period, during which any interested party can write the IRS, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044, to express an opinion about the proposal. There also will be a public hearing in early April. After that, the IRS will determine whether to finalize the existing proposal or submit a revision.
