Cash-Balance Plans: Key Issues

The Bush administration is pushing legislation to ensure the survival of cash-balance retirement plans, which some companies have adopted to replace their traditional pensions.

Cash-balance plans don’t guarantee retirees a set monthly payment, as traditional pensions do. Instead, a company sets up and contributes money to an investment fund, similar to a 401(k) plan, that employees can draw from in retirement.

More than 1,000 companies have adopted these plans, and some employee groups have cried foul. Late last year, a U.S. District Court judge ruled that IBM Corp.’s cash-balance plan was unlawfully discriminatory against older workers. The ruling, which is on appeal, raised a cloud over all such plans.

The legislation supported by the Bush administration would amend pension law to say that cash-balance plans are not inherently age discriminatory. The measure would include safeguards to protect older workers, who typically get the short end of the stick in cash-balance conversions.

Here is a look at some of the key issues involved:

Question: What’s the basic aim of the bill?

Answer: It would provide solid legal footing for companies that want to convert traditional, guaranteed pension plans to cash-balance plans.

Q: Why does the legislation apply only to future plans?

A: Both sides seem to want it that way. Cash-balance supporters say it would be unfair to impose retroactive rules on companies that already have converted their plans. And employee groups that have filed suit to block conversions believe their cases could be undermined by a law that “grandfathers” in existing plans.

Q: What about companies that already have converted to a cash-balance plan?

A: They wouldn’t be affected directly by the legislation. Instead, the fate of their plans would more likely be tied to the outcome of litigation in the IBM case and others under challenge.

Q: What are the benefits of a cash-balance plan?

A: The plans are portable. Those who quit before retirement can take the pension with them; a traditional pension generally must be left with the former employer until retirement. And employees can see how much is accumulated, just as they can see a 401(k) balance.

Q: What are the disadvantages?

A: Traditional pensions usually promise to pay the retiree a set percentage of salary -- say, 50% of the worker’s final monthly pay -- for life, but a cash-balance pension does not. Instead, employers promise to contribute a set amount of pay each year for as long as the worker is employed.

Q: What’s the difference for older workers?

A: Traditional pensions favor older, long-service employees because benefits accrue more rapidly in the final years of employment. Cash-balance plans do not. Benefits accrue relatively evenly throughout a working career. That can put older workers who relied on the old formula at a disadvantage.

In addition, because of the vast disparities in how benefits accrue under the two plans, cash-balance plans often vastly cut benefits to long-service workers who were closest to retirement and least prepared to make up for the loss.

Q: Why the fuss over the plans?

A: Few cash-balance plans are started from scratch. Instead, they’re created by converting an existing defined-benefit pension into a cash-balance plan. In many cases, the point of the conversion was to save the employer money by cutting its future pension liability.

But frequently, employers didn’t explain the downside to workers. Instead they focused on the portability and transparency of the cash-balance structure, giving workers the often misleading impression that they were getting something better than what they had.

Q: Is it legal for employers to cut benefits?

A: It is legal for employers to cut future pension benefits, but employers cannot take away benefits that employees already have earned.

Q: If employers are allowed to cut future benefits, and it was only future benefits that were cut in these conversions, how could employees sue?

A: By and large, the suits were filed contending violations of another portion of pension law, which demands that employers treat all workers relatively equally. In other words, employers cannot favor one group of workers over another.

Many older workers contended that cash-balance plans favored young workers over older, long-term employees.

One relatively common practice, called “wear-away,” was cited as being particularly egregious. It would freeze the pensions of older workers until the amount in their cash-balance plan reaches the amount they had accumulated in their pension plan, which could take years.

Q: What safeguards would be provided by the Bush proposal?

A: It would make wear-away illegal. And it would create a five-year “hold-harmless” period after a conversion, during which employers would have to calculate benefits under both the new and old plans. Employees would get the higher benefit of the two.

Q: What are the chances for the bill’s passage this year?

A: Good, despite the fact that it’s an election year, when controversial legislation is generally a long shot, said Mark Iwry, a former Treasury Department official who is a senior fellow at the Brookings Institution, a Washington think tank.

There are two key factors. Companies are highly motivated to move away from open-ended pensions that guarantee payments for as long as workers live. At the same time, retiree and pension advocacy groups recognize that firms do not need to provide pensions at all. Cash-balance plans are better than nothing, so they, too, appear willing to compromise.