Cash balance furore unabated
Maria Teresa Cometto
They are not your old-fashioned defined-benefit plans. Nor are they your new defined-contribution plans. Certainly, they are under fire and a huge amount of criticism, especially by older employees. The new cash balance pension plans are the hottest issue in the American pension industry. European companies should think twice before deciding to import this model, even if it would allow them to save a lot of money in funding employees’ retirement plans.
A cash balance plan is a defined benefit plan, which creates a hypothetical account for each employee. The employer contributes annually to each ‘account’ with an amount equal often to 3 % to 5 % of pay. In addition, each account earns an interest rate specified by the employer, often near the long-term Treasury bond rate (currently 5.8%). On one hand, each employee can watch his account grow in value, year by year, as he could do with a defined contribution plan. On the other hand, the plan is still
a defined benefit one, because
the assets are pooled and invested as the employer wants, while the
individual accounts are only bookkeeping entries.
Why don’t older employees like them? With traditional plans, retirement benefits are heavily weighed towards the worker’s highest average pay, usually in the last years of the job. Instead new plans are career average ones, that accrue gradually each year. Younger employees like them, because they start accruing pension benefits earlier and they are easier to roll over in new accounts, when changing jobs.
The troubles for older employees begin when their companies switch from their old plan to a cash balance one. According to Robert Pennington, a pension specialist at the College for Financial Planning: “Older workers could lose 20% to 50% or more under a new cash balance plan compared with what they might have earned under their traditional pension plan”.
Such a proposed switch to a new cash balance plan enraged IBM employees in 1999. The critics – IBM’s and other companies’ older employees – have taken their case to the courts, the Internal Revenue Service, the Labor Department and Congress. The controversy over new cash balance provisions is one reason why a giant package of retirement-savings legislation is still pending in Congress. Issues involved are whether these plans
and conversions violate age-discrimination laws, the 1974 Employee Retirement Income Security Act,
IRS regulations or other employee protections.
Norman Stein, a professor of pension law at the Alabama University, supports the criticism: “most cash balance plans have been designed to hurt older employees. After years of having a plan that is not good for young people when they are young, when they get older they get a plan that is not good for older people”.
Employers, such as IBM, argue that cash balance plans are needed to attract and retain younger employees, who now tend to move more readily from one job to another. Others point out that the old plans benefit more a relatively few higher-paid, longer-serving workers, while the new ones redistribute benefits throughout the workforce and make them better for three quarters of the employees.
But some companies have also admitted that they have been altering pension plans to get rid of early-
retirement incentives: in fact the plan conversion forces older workers to stay on the job longer than planned. Most companies take steps to
ameliorate the problem. Some give extra-credits to older workers or let them remain in the old plan. But not all companies do this.
The effect on corporate financial numbers is clear. Pension costs for the companies in the Standard & Poor’s 100 index dwindled in 1999 to
$155m from $4.9bn in 1997,
according to a study by R G Associates Inc, a firm which periodically reviews the role that pension plans play
in American corporations’ results.
For 29 companies – among the
100 reviewed – the income generated by pension assets was so strong
that the plans not only paid for
themselves, but also helped to
boost corporate earnings.
“Clearly, the stock market is the key”, comments Jack Ciesielski, partner with R G Associates,“but the increasing popularity of cash balance pension plans, which reduce
a company’s liability, has also made a big difference”.