Pension Trends   Volume IV, No. 4, November 2003

In this issue...

Cash Balance Plans - Facts and Fictions

Cash balance plans have been in the news a lot lately. Generally, the news has been negative. In July, a court ruled that the cash balance plan of IBM was age-discriminatory. The logic applied by the judge in the IBM case runs contrary to long-accepted pension principles, but the decision stands as the latest blow to cash balance plans, at least for the time being.

What caught my attention was an article about cash balance plans in a recent AARP Newsletter. Unfortunately, the article was full of inaccuracies and misleading statements. Here are some important facts and common fictions about cash balance plans.

Fact: Cash balance plans are a kind of defined benefit plan. They have some characteristics of a defined contribution plan, but the investment risk is borne by the plan sponsor, not the participant. A cash balance plan is sometimes called a hybrid plan. A Pension Equity Plan is another form of hybrid plan.

Fact or Fiction: Cash balance plans provide lesser benefits than traditional defined benefit plans? Fiction. There are rich cash balance plans and there are modest cash balance plans just like there are rich and modest traditional DB plans. An employer that contributes $1 million per year to a cash balance plan will provide the same total benefits to employees as it would with a $1 million per year contribution to a traditional plan.

Fact or Fiction: An employer that converts from a traditional DB plan to a cash balance plan is doing so to save money? Maybe. There are two principle reasons for an employer to convert to a cash balance plan. A cash balance plan is easier for employees to understand than a traditional DB plan. This is primarily because benefits are described in terms of an account balance. Secondly, a cash balance plan generally provides higher benefit accruals in the early years of employment. For today’s mobile workforce, a cash balance plan should get more dollars into the retirement accounts of younger workers. Whether an employer saves money by converting to a cash balance plan is a decision made by the employer independent of the type of plan.

Fact or Fiction: Older workers fare less well in a cash balance plan? It depends on who you ask. If you ask an older worker of an employer that sponsored a rich traditional DB plan and converted that plan to a cash balance plan a la IBM, then the answer is yes. If you ask the older worker of an employer that does not sponsor any retirement plan – and that is still the case for the majority of small employers – a cash balance plan sounds pretty attractive. The older worker whose 401(k) account is only half of what it was once may also look favorably at a cash balance plan.

Fact or Fiction: Cash balance plans are only for larger employer? Fiction. There are lots of applications for small employers. Whether a cash balance plan makes sense for an employer depends upon a number of financial and demographic factors. In some instances, a cash balance plan can do a better job of distributing benefits to the desired portion of the work force than a traditional DB plan.

Fact or Fiction: Cash balance plans (and the other hybrid plans) are a thing of the past. The fact is no one knows. Given an honest, intelligent evaluation, a cash balance plan can be shown to be a valuable, appropriate benefit plan that provides meaningful benefits to employees. But look what unending bad publicity caused by a few individuals did to Arthur Anderson. It is possible, albeit unlikely, that negative press will have the same long-term affect on cash balance plans. Until Congress is through tinkering with cash balance plans, we are advising our clients to wait. Eventually the picture will clear but until then what you hope to get from your cash balance plan might not be what Congress ultimately bestows on it.

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Pension Trends, Volume IV, No. 4, November 2003
Copyright © 2003 Independent Actuaries, Inc.