12 16 1 amount of their total benefits to career employees during their last few years of service, as plan, with an individual “hypothetical” account that appears to accumulate assets for each true even though the cash balance plan illustrated in this chart adopts a service similar about two VanDerhei, Jack L. "The Recapture of Excess Pension Asse definition, replaces 50 percent of preretirement earnings after 25 years of service. of cash balance savings, if any, since any savings due to cash balance plan conversion may be Gebhardtsbauer, Ron. “Testimony on Cash Balance Plans, Conversions and Disclosure.” For the unexpected increases in early retirements during a strong bull market and unexpected delays of Of course, an employer that sponsors a final • Disclosure requirements. to that experienced by the participant who remains under the cash balance plan for the -thirds of those who offered answers about early retirement we Provide extra account balances to make up for the fact that final average earnings will Under current law, plans are required to notify participants of -average plan also has the alternative of ts." Benefits Quarterly re wrong (Mitchell, -weighted pay However, to . Vol. 1, no. 3 Key Issues in the Cash Balance Debate I. Table 1: Primary Type of Benefit Formula References Chart 3: Illustration of a conversion from a hypothetical traditional final average defined 10 18 benefit plan to a hypothetical service weighted cash balance plan (without transition 1988). In contrast to explaining the complex benefit formulas used by traditional defined benefit understand the extent to which cash balance benefits will replace preretirement earnings is far demonstrated in retirement during a marke any amendment that will result in a significant reduction in the rate offset by other increases in benefits or compensation. entire 40 years. As a consequence, the participant will not end up with the same financial credit schedule. terminating the existing defined benefit plan (assuming it is adequately participant. Cash balance plan accounts are a record U.S. Department of Labor ERISA Advisory Council, May 6 and June 9, 1999. (Third Quarter 1985): 1 not be directly used in the formula. Chart 3. Career t correction (especially if it is prolonged). – -13. average plans pay benefits based on a greater number of years -keeping feature only, as these plans are of future funded) and setting up a benefit accruals at Chart 5. Percentage of 401(k) participants with Jack L. VanDerhei, Temple University, EBRI Fellow credits) at age 55 Chart 4. HYPOTHETICAL percentage increases in Alderson, Michael J., and Jack L. VanDerhei. "Disturbing the Balance in Corporate Pension 22 VanDerhei, Jack L., and Russell Galer, Carol Quick, and John Rea. position at age 65 but, barring any transition prov Ippolito, Richard, A. Pension Plans and Emplo funded on an actuarial basis, in the s least 15 days before the amendment takes effect. defined contribution plan through which to provide benefits for future service. However, several more difficult, since cash bala of service (e.g., 30 years rather than five). As a result, a career plans, conveying information through theoretical account balances under cash balance plans A difference in accrual rates between older and youn Retirement benefit predictability Assuming such a calculation was performed, the cash balance plan may also prove to be nce plans are a type of a career ame way that defined benefit pension plans are funded. . Since employers directly bear investment risk under yee Performance: Evidence, Analysis and Policy. isions, would experience a decrease in pension However, present law does not require - ger workers upon conversion from a average formula that provides -average plan tends to provide 401(k) Plan Asset Allocation, • Provide a supplemental additional benefit. 1995 1996 1997 1998 1999 Chart 2. Defined Chart 1. Defined contribution contribution annual benefits at NRA Cash Balance vs Final zero exposure to diversified equities: 1996 Sept. 21, 1999, Senate Health, Education, Labor and Pensions Committee Policy: The Case of Excess Asset Reversion Legislation." Benefits Quarterly (Third final cash balance plans, they need not worry about overly conservative worker facilitates employee appreciation of both curre more expensive than originally calculated if turnover is higher than assumed. This would result interest credits that are likely tied to some external financial market vehicle and/or index. individual notices for each plan participant and does not require disclosure as to the effect the less protection against the effects of preretirement inflation on the value of considerations may make this option problematic: wealth of approximately 23 percent. Therefore, at any point in time, the benefits promised to a participant are based on the plan -average to a cash balance plan is likely to exist whether or not a so Chicago: University of Chicago Press, 1998. Account Balances, and Loan Activity. nt pension wealth and the annual pay and interest Joint EBRI/ICI publication, (January 1999). -called wear benefits payable at -investors. Chart 5 -away $300,000 A PricewaterhouseCoopers survey of about 75 cash balance conversions reveals that in T-121 Number of employers 836 825 805 791 773 Average Plan: impact of job tenure Quarter, 1991): 38–51. 8 growth growth : active : number of plans participants plan amendments will have on individua retirement than final formulae and not on the assets in his or her “account”. provision (explained later) is included in the plan. The difference is conceptually similar to the credits that increase pension value over time. Metras, Rita D. Testimony for the Hearing on Pension Reform Legislation. U.S. Senate from plan assets being reduced below expected levels, and the spread between Wang, Jennif below shows the 1996 percent Lump Another significant difference between a traditional defined benefit plan and a cash Ease of conversion vs. new plan establishment er, and Jack L. VanDerhei. “The Impact of Primary Pension Trends on Retirement -sum distributions -average plans. age of 401(k) participants with zero exposure to diversified . Due to the increased likelihood that participants in a cash Table 1 below demonstrates that for respondents to a l participants. . Whereas a conversion from a final the accrual in the - almost all cases the employer provided transition provisions beyond the legally required $250,000 50% Highest average pay 82% 81% 78% 77% 72% 100% Allen, Jr., Everett T., Joseph J. Melone, Jerry S. Rosenbloom and Jack L. VanDerhei. 19 Pension 45% balance plan concerns the inherent uncertainty involved in estimating the nominal amoun effects of changing a final equities by age cohort (VanDerhei, Galer, Quick, and Rea, 1999). Although approximately one survey of the large U. S. employers offering a defined benefit plan, the percentage utilizing a plan and the actual fund performance may be a factor in increased costs. av balance plan w erage defined benefit plan to a cash balance plan only requires a plan amendment (Rappaport, Income: A Re Recently, some have argued for the need to disclose to each employee the differences in In a typical cash balance plan, a participant’s r No magic numbers of age and service Committee on Finance, June 30, 1999. ill end up with a LSD as opposed to a lifetime annuity, it is more likely that they -examination of Defined Benefit/Defined Contribution Trend.” -average plan to a career . Final -average plan or, more drastically, terminating etirement account grows by earning annual -average defined benefit plans often require Turnover could t of - minimums (Sher, 1999). $200,000 A. 80% Abstract 70% 40% 5-year average 62% 61% 60% 58% 55% Planning: Pensions, Profit Sharing, and Other Deferred Compensation Plans. Eighth 80% retirement income. Traditional defined benefit plans are not typically thought of in this regard Young, Levell, and Blalock, 1997), terminating the same plan and setting up a successor defined final increase due to future labor patterns that impact all employers, but it might also increase as a credits that may be based on a flat percentage of pay but that might be integrated with Social his or her accrued benefits under the previous plan formula and his or her initial account balance Milne, Deborah A., Jack L. VanDerhei, and will face a longevity risk in addition to a post half of these individuals in each age cohort have some equity market exposure through company employees to satisfy some combination of age and service before they are a defined benefit plan and establishing a defined contribution plan. However, the magnitude of -average formula decreased from 82 percent (forthcoming) 60% Benefits Quarterly. -Paul J.Yakoboski. "Can We Save Enough to Retire? retirement investment risk. It should be noted, to 72 percent over the last 5 years. Similarly, entitled to retire with $150,000 Wearaway. The trend among large companies toward conversion from traditional final If a final-average plan is converted to a cash balance plan, the initial value of -average 35% 3-year average 60% 17% 17% 16% 16% 15% Statement Before the edition. Homewood, IL: Richard D. Irwin, Inc., 1997. 11 50% 30% Warshawsky, Mark J. “Funding of Defined Benefit Pension Plans.” In Mi since the amount is specified in a formula and (with the exception of certain integrated plans) can Security benefits (Quick, 1999). However, it is also possible to provide age or service direct consequence of providing a more level benef under the cash balance plan. Moreover, they have arg stock an contribution plan may trigger a reversion excise tax of either 20 p the difference is influenced by plan however, that with some exceptions, cash balance plans are required to off the percentage utilizing a career an early retirement subsidy, and the magnitude of the dollar loss from leaving prior to that time Participant Education in Defined Contribution Plans?" d/or balanced funds, a significant percentage of them may be subjecting themselves to -average pay formula declined from 12 percent to 9 percent. -specific design parameters. it accrual over time that decreases the “job ued that the wearaway period (if any) EBRI Issue Brief ercent or 50 percent (Alderson chael Gordon, Olivia S. er annuities as an no. 160 -weighted a participant’s cash balance account defined benefit plans to cash balance plans has precipitated one of the most complex pension may be set at less than the value of benefits accrued under - $100,000 60% Other (e.g., 10-year average) 3% 3% 2% 3% 2% 40% 25% 40% Auer, Mary Jane. “A Mixed Bag for NationsBank.” Institutional Investor. Vol. 33, no. 1 lock” attributes of the existing plan. option to their participants, and it appears that there is an increasing propensity for traditional and VanDerhei 1991). If the defined benefit plan was overfunded, the surplus in a conversion to During that same period of time, utilization of cash balance plans increased dramatically, from 6 pay credits under the expected rates of return too low to generate sufficient retirement income at normal retirement be directly computed once the average compensation an can be substantial (Ippolito, 1998). In contrast, the accrual pattern under a cash balance plan during a conversion should be explained, and a meaningful comparison should be provided to (Employee Benefit Research Institute, April 1995). Employees faced with t Mitchell, and Marc Twinney, eds., Senate Health, Education, Labor and Pensions Committee se plans, even though a cursory examination of Internal Revenue Code he type of graph shown in Chart 3 are likely to wonder why the Positioning Pensions for the Twenty d years of participation are known. -First Century. the previous plan. However, it is important to note that this may not reduce or take away related controversies of the late 1990s. Current debate appears to focus on both the effects of $50,000 20% one job 40% 30% 20% Career average pay (January 1999): 126. 12% 12% 11% 4 10% 9% 15% four jobs age. a cash balance plan would be used to reduce future contributions (as it would under the typically does not have a sudden, ra each worker of projected benefits under the amended plan compared with benefits that would Mitchell, Olivia S. However, it appears that an increasing percentage of defined benefit participants are now percent to 16 p (IRC) Sec. 411(b) would suggest that this violates the 133 final shapes look different. The difference essentially lies in the different determinants of benefit - average defined benefit plans to offer LSDs and for participants to choose them when However, there may also be Philadelphia: University of Pennsylvania Press, 1997. ercent of all large defined benefit plans surveyed. “Worker Knowledge of Pension Provisions pid increase after attainment of specific age and service short-term abnormalities in the pension cost and/or expense -1/3 percent rule. ,” Journal of Labor Economics Cash balance plans . these conversions on expected retirement incomes and on the manner and extent to which previously earned benefits. It may mean, though, that initially some workers won't accrue any $0 20% 10% 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 20% Bone, Christopher M. Statement before the ERISA Advisory Council Working Group on Hybrid 0% structure resulting from the conversion. In essence, the claims of cost savings from offered (Watson Wyatt, 1998). Also, even thou receiving their distributions in the form of lump criteria. As a result, cash balance plans are more attractive to a mobile work force. value under each type of plan. While the present value of the annual accrual of pension wealth also provide a yield on the hypothetical account that is typically defined as either the 3 have been earned under the previous traditional plan); if it was underfunde Watson- Funding flexibility Questions often arise as to what forces have caused this acceleration over the last few Vol. 6, no. 1(January 1988): 21 Wyatt. “Choosey Employees Choose Lump Sums!" . Finally, a cash balance plan may have more fundi d, the unfunded liability is amortized in the normal fashion plan formula. This appears to be based on a belief that it is –40. -sum distributions (LSDs) gh cash balance plans communicate benefits in Age Watson Wyatt Insider – a form that can ng flexibility than a conversion . Vol. 8, no. 4 0-year companies must disclose these effects to participants. This testimony provides background new benefits until the pay and interest credits to their hypothetical accounts bring the account Cash balance 10% 5% 6% 7% 9% 11% 16% Source: Author's tabulations based on assumptions in Purcell (1999) with the following modification: the benefit accrual rate was decreased to 0.91 percent to allow for benefit 35 45 55 65 equivalence of the two programs assuming 40 years of participation in the same program. Plans. U.S. D 0% epartment of Labor, September 9, 1999. 5 0% -20% 0% (Warshawsky, 1997). a defined contribution plan, depending on the type of commitment made to employees. terms of a lump to a cash balance plan may be at least partially due to a timing issue under the accounting and/or Treasury rate or the one expressed as a percentage of compensation under a final years. Although the Employee Benefit Research Institute (EBRI) surveyed current, future, and critical for plan participants to have an appropriate opportunity to (a) voice their concerns provide great uncertainty to employe Morrow, Rebecca. “Conversions To Cash Balance Plans Highlight Importance of Defined Higher benefits to employees who do not stay with one employer for their entire career (April 1998). -sum account balance, at least some of them limit the ability of employees to -year T-Bill rate plus a stated percentage (Gebhardtsbauer, 1999). es with respect to the amount that they will receive due to -average plan at any point in time . information on issues surrounding cash balance plans, including the controversial “wear balances up to the value of the old protected benefits. -away” cash balance (service weighted) traditional final average defined benefit plan conversion at age 55 (without transition credit) Pension equity 20s 30s — — 40s 1% 50s 2% 60s 3% Burlingame, Harold W., and 17 Michael J Gulotta. “Casestudy: Cash Balance Pension Plan Although some profit funding rules required for all defined benefit plans (including cash balance plans). Although the potential hybrid ret cash out their accounts. depends on age, service, and pay, it depends predominantly on pay and service (and a lesser regarding plan amendments so that employers are fully aware of them and (b) alert regulators to White, Elizabeth A., “Cash Balance Plans Attorney Urges IRS Rules to Clarify Age Chart 4 shows the perc fluctuations in the relevant discount rates (Bone, 1999). In contrast, cash balance plans provide C. Contribution/401( Guarantee of employee participation Trends irement plan sponsors in June 1995 (Campbell 1996), it does not appear that -sharing plans provide for annual contributions that are entirely entage increases in annual retirement benefits at normal retirement age for k) Approach.” IOMA’s Defined Contribution Plan Investing. . The noncontributory nature of most (if not all) - provisions utilized by some plans. Employers have flexibility in how they credit wo Hearing on rkers for the value of their benefits, and -40% Facilitates Restructuring the Workforce at AT&T.” Compensation and Benefits Review N.B.: approximately 1/2 of these participants have Other (e.g., fixed dollar only) <1% <1% 1% <1% <1% LSDs that are stabilized, but annuity values under these arrangements may be subject to iss calculations are complex, one of the driving discretionary for the plan sponsor (Allen, Melone, Rosenbloom, an similar surveys have been published subsequently. However, it is likely that regulatory an employee in a hypothetical cash balance plan versus a hypothetical final extent on age) under a cash balance plan. Therefore, even if the overall cash balance plans eliminates the need to worry about employees who choose not to particip ues surrounding cash balance conversions that they deem important (White, 1999). H. Charts 1 and 2 (below) report numbers of plans and active participants over time to Discrimination Issues in Conversions. Vol. 26, No. 32 (August 16, 1999): 2407 September 1999. Key Issues forces behind this shortd VanDerhei, 1997), a defined -term cost reduction involves generosity of a plan -average defined ate this result could be obtained by computing the opening balance of a participant’s cash balance B. Introduction Attained age (entry age = 25) Defined contribution as a percentage of total Hybrid Pensions Defined contribution as a percentage of total (November/December 1998). Source: EBRI tabulations based on tables from Patrick Purcell, P exposure to company stock and/or balanced funds ension 21 the computation of the cost of accruing a benefit based on career benefit plan is the only vehicle that will allow employees to continue their normal benefit fluctuati benefit plan. The figures in this chart are tabulated from a CRS report to Congress tha Williamson, Christine. “Stock Allocation Hikes Predicted as Defined Benefit Plans Shift Olsen, Kelly, and Jack L. VanDerhei." Defined Contribution Plan Dominance Grows Across demonstrate the well clarifications of certain technical aspects of cash balance plans (such as those provided i However, others in the pension policy community have questioned the logic in providing or make remains the same after conversion to a cash ons in annuity purchase prices although it appears some employers are willing to hold In recent months, there has been a flurry of press accounts, court cases, and le de minimis contributions in a 401(k) arrangement (Yakoboski, 1994 and Milne, -known trend from defined benefit to defined -balance formula, higher accruals for young -average pay (the cash balance contribution plans since the gal and t includes n 1996 to Cash plan by using a discount rate that is higher than the current 30 The recent trend among large employers toward conversion of traditional final 100% 100% -year Treasury bond rate. 100% 100% -average 100% Issues: Cash-Balance Plans, CRS Report for Congress, May 24, 1999 Source: tabulations based on U.S. Department of Labor, Pension and Welfare Campbell, Sharyn. "Hybrid Retirement Plans: The Retirement Income System Continues to Source: tabulations based on U.S. Department of Labor, Pension 9 6 and Welfare 20 employees means that accruals for older employees will likely decrease unless some type of passage of the Employee Retirement Income Security Act of 1974 (ERISA). accruals while employer contributions are reduced or even temporarily curtailed. plan) for one based on final estimates under a benefit plan that no longer exists and have warned that Congress sh calculations for two types of employees: (a) one who enters the employer’s plan at age 25 and annuity purchase rates constant in the plan (Gebhartsbauer, 1999). regulatory activities with respect to cash balance plans, specifically as they relate to conversions when the Internal Revenue Service (IRS) issued Notice 96 VanDerhei and Yakoboski, 1995). As a result, employees are guaranteed a benefit under a cash Sectors and Employer Sizes, While Mega Defined Benefit Plans Remain Strong: Where Balance.” Pensions & Investments, -average pay under the previous plan (Demby June 1999). (September 6, 1999):1ff. -8 ) were important catalysts for many Recent research ould and career As pointed out in recent -average defined benefit plans to cash balances has raised a controversial and complex Benefits Administration, testimony to the Private Pension Plan Bulletin ERISA Advisory Council Working Group (Spring 1999) Source: 401(k) Plan Asset Allocation, Account Balances, and Loan Activity by Jack VanDerhei, Source: Hewitt Associates SpecBook™ return Benefits Administration, Private Pension Plan Bulletin (Spring 1999). Russell Galer, Carol Quick, and John Rea, Joint EBRI/ICI publication, January 1999 Evolve." EBRI Issue Brief no. 171 (Employee Benefit Research Institute, March 1996). 1 2 2 3 grandfathering or transition provisions (explained below) proceed very cautiously in adding to the already substantial burdens of administering a cash (Wang and VanDerhei, 1999) confirms that these trends are at least as large when measured by balance plan without needing to actively choose to participate in the pla of the more recent conversions from “traditional” defined benefit plans to those of the cash remains in that plan for 40 years and (b) one who changes jobs every 10 years (Purcell, 1999). Yakoboski, Paul J. “Male and Female Tenure Continues to Move in Opposite Directions.” from existing final E. G. We Are and Wh Transition/grandfath Potential Advantages: Cash Balance vs. Final Average Plans Potential Limitations of a Conversion From a Defined -average plans. This section of the testimony provides some insight into each ere We Are Going." In Dallas L. Salisbury, ed., ering. Several transition methods are available to a sponsor that are provided to older workers. For n, and the plan is Benefit to a Cash Balance Retirement Prospects in EBRI set of issues. studying hybrid plans, A cash balance plan is a “hybrid” type of pension plan benefit formulae that end up resulting in periods with no new accruals for —i.e., one that takes on the Clark, Robert, Gordon Goodfellow, Sylvester Schieber, and Drew Warwick. “Making the Most financial flows (i.e., benefits accrued and/ chooses to mitigate the financial impact that may result in a switch from a traditional final Comparing the two sets of bar graphs, one can see that example, an employee participating in the hypothetical final balance or other defined benefit plan (Metras, 1999). Employers may be unreceptive to protected from possible disqualification due insufficient participation among lower of these in an attempt to clarify some of their m balance variety. Plan Notes Before discussing key public policy issues a a Defined Contribution World. (February 1999). or employer contributions). Washington, DC: Employee Benefit Research Institute, ore complex and controversial concepts. nd the possible ramifications of modifying for a hypothetical individual staying at -average defined benefit plan in -paid workers. - characteristics of both a defined benefit plan and a defined contribution plan. Legally, a cash some employees have been a practice approved by the Internal Revenue Service for many years by of 401(k) Plans: Who’s Choosing What and Why?” Working Paper 98 23 -12. Philadelphia, projecting future benefits due to the extremely sensitive nature of the Yakoboski, Paul J. "Salary Reduction Plans and Individual Saving for Retir average plan to a cash balance plan (Rappaport, Young, Levell, and Blalock, 1997): the existing legislative and/or regulatory landscape, it may be helpful to consider why a sponsor Chart 3 would have a present value from his or her defined benefit plan at age 55 of the same job for his or her entire life, the cash balance plan provides a larger benefit after the Although these trends are heavily dominated by small plans (Olsen and VanDerhei, Although using a cash balance plan to provide benefits that are easily communicated, In contrast, Clark, Goodfellow, Schieber, and Warwick (1988) found that less than half of 1997, pp. 55 Do Cash Balance Plans Result in Cost Savings to the Sponsor? –92 estimates. ement." It is certainly possible EBRI Issue balance plan is a defined benefit plan. A cash balance plan offers some of the popular (Chambers, 1999). Often plan changes, such as updating plan mortality assumptions, the D. Fundamental Economic Distinction Between Fin Jack VanDerhei, Temple University al-Average and Cash Balance PA: Pension Research Council, October 1998 13 typically provide no investment risk to employees, and maintain the funding flexibility inherent first 10 and 20 years of service. But, by age 55, the final 1997), large employers that continue to sponsor defined benefit plans are less frequently utilizing of a final approximately $95,000, as opposed to app all workers age 20 Purcell, Patrick. “Pension Issues: Cash for conversion to a cash balance plan to result in lower Brief • - average defined benefit plan may be interested in converting to a cash balance plan: Pay the great no. 155 (Employee Benefit Research Institute, November 1994. -29 earning less than $15,000 p er of the benefit that would have been paid under the old plan and the -Balance Plans.” roximately $135,000 for a similar employee who had er year contributed to their 401(k) plan. This long CRS Report for Congress -average plan is slightly more valuable, -term pension expense, depending on . (May 24, advantages of a defined benefit plan but is designed to look more like a defined contribution resultant standardization of disparate pension plans as a result of mergers and acquisitions, or Plans and Fellow, Employee Benefit Research Institute Chambers, Robert. Testimony on behalf of Association of Private Pension and Welfare Plans. and by retireme participated in the hypothetical cash balance plan for the same period of 30 years. However, if in a defined benefit plan may appeal to ma the generosity of the new plan re “traditional” benefit formulas, such as “fin Ease of communicat 1999). benefit due under the new formula for a subset of the employees (either for a limited nt age the benefit derived from the final ion vs. invisible plan syndrome. lative to the existing plan. In essence, this is no different than al ny employers, cash balance plans also present several -average” and “career -average plan would be 30 percent larger - Sponsors of traditional defined average pay” formulas. Final even revising a plan to meet new statutory requirements (such as legislative change has led some to speculate that 401(k) plans are being adopted as a supplemental (as opposed to s to the Sec. Washington, D.C. Under either the final-average or cash balance plans illustrated in Chart 3, an employee Congel, Colleen T. “Cash Balance Plans Rep. Sanders Repeats Call for Review of Cash Balance 7 switching from a defined benefit to a defined contribution plan, and similar projections would the hypothetical final average plan were then converted to the hypothetical cash balance plan tradeoffs: average plans offer automatic preretirement inflation protection than the cash balance benefit. However, this “one benefit plans often bemoan the lack of recognition they receive from their employees, even replacement) plan for a traditional defined benefit plan, and that the additional cost of the Quick, Carol. “An Overview of Cash Balance Plans.” time period or until termination or retirement). -job for life” scenario only applies to small EBRI Notes and provide a substantial (July 1999): 1–8. 401(a)(17) limits earlier this decade) can result in periods without new accruals. 1 This testimony is partially based on Jack VanDerhei, “Key Issues in the Cash Balance Debate,” ACA Journal starting at age 25 will obtain the same benefit value at age 65 if he or she remains with the same Age-Discrimination Issues.” BNA Reporter. Vol. 26. No 35 (September 6, 1999): 2179 without the pr need to be applied to determine if this were the case (VanDerhei 1985). However, even if suc Rappaport, Anna M., Michael L. Young, Christopher A. Levell, and Brad A. Blalock. “Cash percentage of the work force (Yakoboski, 1999). Employees are more likely to though substantial sums of money are contributed and/or accrued annually. When the quality of Smaller accruals for older workers ovision of any type of transition credit, the employee would not benefit from the . As mentioned earlier, unless some type of transition have four, if not h a supplemental plan is (forthcoming), and • Provide extra account balances at transition to ma William Gale, Leslie Papke and Jack VanDerhei, “Understanding the Shift Toward Defined being offset by reductions in the cost of the original plan. One way this ke up for the greater benefit which 21 September 1999 Contribution Plans,” paper presented at t employer for a full career. Nevertheless, the accrual rates under each plan differ fundamentally. he Brookings/TIAA-CREF Institute/SIEPR conference ERISA After 25 Demby, Elayne Robertson, “Cash Balance Converts.” Plan Sponsor (June 1999): 22 14 -30. 4 calculation was performed on two retirement plans, it would not necessarily indicate the extent more, jobs during their careers. The second set of bar graphs show that in those cases, the series work benefits are provided, older employees are likely to receive smaller accruals for their remaining rapid escalation in pension wealth from age 55 to 65 that is associated with the final average ers' information regarding traditional pension offerings was evaluated, Balance Pension Plans.” In Michael Gordon, Olivia S. Mitchell, and Marc Twi about onenney, eds., -third of could be accomplished is by the substitution of a cash balance plan for a traditional final The plan design constraints otherwise provided via the anti would have been available at early retirement. -backloading provisions appear to be mitigated due to -average Years: A Framework for Evaluating Pension Reform, September 17, 1999. the assumption that early pay credits will earn more interest credits by retirement age. The annual increase in benefit value (viz., how much additional retirement income an employee ____, “Cash Balance ‘Whipsaw.’” Plan Sponsor (May 1999): 74–76. 2 workers queried were unable to answer any questions about early retirement requirements, and plan. Instead, during the final 10 years he or she would experience a slope of yea of cash balance plan benefits dominate those accrued under the final This testimony purposefully avoids taking a stance on the ongoing debate regarding concerns that cash balance rs, regardless of whether a “wearaway” provision (described below) exists. Positioning Pensions for the Twenty-First Century. Philadelphia: University of -average plans at every age, the accrual path defined benefit plan. 5 20 One factor that may be a constraint on adoption of these plans in the current financial markets is that many plan conv See Bone (1999) for a more complete description of the calculations required under FASB Statement No. 87. ersions may be violating age discrimination laws. The IRS, EEOC and Labor Department share will earn by working one more year) tends to be much higher for young employees under the Employee Benefit Research Institute. Cash Balance Debate Heats Up.” 15 EBRI's Washington 18 participants in defined contribution plans have come to expect annual returns far in excess of these rates and the final retirement benefits are app Pennsylvania Press, 1997. Preretirement income replacement roximately 40 percent larger. . Although their understanding of current pension responsibility for enforcing U.S. age discrimination laws and none of the three agencies have provided guidance on For example, Eastman Kodak reportedly will introduce a first ti Retirement pattern predictability. Investment risk is typ me match to its 401(k) plan to counterbalance ically directly borne by 21 Sher (1999, p. 22) reports that more than two-thirds of the plans included in the PricewaterhouseCoopers survey (approximately 6 percent currently). However, for technical reasons enumerated in IRS Notice 96-8, employers cash balance plan and much higher for older employees under the final-average plan. This is losses from its conversion from a final average plan to a cash balance plan (Morrow, 1999). the age discrimination question. Moreover, there appears to be a complete lack of any benchmark court decisions A pdf for the complete document submitted for the record (including charts, tables and footnotes) is available at: Bulletin. Vol. 11, no. 18 (September 3, 1999). 12 used an interest rate that was approximately equal to or less than 30-year Treasury bond rate at the time of the Schultz, Ellen E. “IRS Tells Field Offices to Hold Off on Clearing ‘Cash Balance” Plans. wealth and future increments will no doubt improve vis F. Potential Advantages: Cash Balance vs. Defined Contribution Plans -à-vis the previous final-average plan, Wall employee's hypothetical account under a cash balance plan has to be projected to normal retirement age, and then employers under a cash balance plan and by employees under a defined contribution plan (see Note that they will not be exactly equal given that the pay credit differs from the assumed interest credited to the providing a rate of return in excess of one of these indices would be subject to the “whipsaw” problem. In brief, this that speak to this issue (Martin, 1999b). In addition, the topic is made more complex by the fact that preferences, to 19 www.ebri.org/testimony/T121.pdf conversion. However some employers may desire to use a higher discount rate because the current 30-year Treasury In addition to the potential cash flow problems arising from increased LSDs under cash balance plans, the liability the employee must be paid at least the present value of that projected hypothetical account (White 1999). cash balance plan (5.6 percent). would potentially require the plan sponsor to pay lump -sum distributions (LSDs) that were larger than the Gale, William, Leslie Papke, and Jack VanDerhei. “Understanding the Shift Toward Defined the extent they exist, may be related to service as opposed to age. It a ppears that IRS is now examining whether employees actually may be more uncertain about how their future benefits will relate to their Street Journal (Interactive Edition), 17 September 1999. bond rates are low relative to historical levels. The wear durations of cash balance plans appear to be between seven to eight years as opposed to the 12 Auer 1999, however, for one notable exception). As a result, the employer is better able to -away period actually experienced by a participant will be a - to 20-year durations 13 10 hypothetical account balance (significantly so – as a percentage of the account balance – for young employees) conversions to cash balance plans involve violation of age discrimination laws and will be expressing its views to 8 The views expressed in this statement are solely those o In addition to these retirement plan All assumptions for this chart replicate those in Purcell (1999) with the exception of the benefit accrual rate which -specific reasons, there may also be overall compensation or administrative f the author and should not be attributed to the Employee function of the differential between the opening cash balance account and the present value of the accrue Cash balance plans actually are a type of career -average plan, in that benefits are based on career-wide earnings. d benefits 16 typically calculated for traditional final average plans. Although the eventual impact (once the various transition because IRC requirements appear to require account balances to be accumulated out to retirement age and then Contribution Plans.” Paper presented at the Brookings/TIAA-CREF Insitute/SIEPR this Senate panel (Martin, 1999a and Schultz, 1999). The calculation is obviously more complicated in an integrated plan. future earnings after conversion to a cash balance plan. For example, a final Sher, Larry. “A Workable Alternative to Defined Benefit Plans.” concerns that are sp was decreased to 0.91 percent to allow for benefit equivalence of the two programs assuming 40 years of Benefit Research Institute, its officers, trustees, sponsors, or other staff. The Employee Benefit Research Institute is ecifically addressed through a conversion. Two of the more common reasons include supporting Contingencies. -average plan that predict retirement patterns under a cash balance plan, since retirement income will not be under the previous defined benefit plan, as well as the future changes in discount rates. If the discount rate falls after provisions allow more However, for purposes of this testimony, “career of the liabilities to be generated via the new cash balance component) of the decreasing -average” only refers to traditional career-average pay formulas. 22 discounted back to the current age at the 417(e) discount rate (Demby, May 1999). Previously accrued benefits are protected by IRC Sec. 411. 17 15 3 a total compensation philosophy in the context of a new performance participation in the same program. T a nonprofit, nonpartisan, public policy research organization. he pay credits varied as follows: years 1 -based arrangement with employees and -10: 4 percent, 11-20: 5.5 percent, 21- the conversion, the present value of the previous benefits will increase, and the wear liability durations on the plan sponsor’s asset allocation is debatable (Williamson, 1999) it would appear that the Although this testimony focuses exclusively In the case of the job For example, at AT&T, employees can receive a cash payment for the entire amount in their accounts if the conference, ERISA after 25 years: A Framework for E -changer, it is assumed that the full amount of any cash balance proceeds would be on cash balance plans, hybrid arrangements that combine traditional valuating Pension Reform -away period experienced by the , reinvested 9 6 pays 2 percent of an employee’s average earnings during his or her la IRS Notice 96 (September/October 1999): 20 -8 provided proposed guidance on applying tax code Secs. 411 and 417(e) to cash balance plans. In –26. st three years of service, by 23 susceptible to market fluctuations. Under a defined contribution plan, employers may face 40: 7 percent. providing a platform for merging disparate pension plans as a result of merger and acquisitions activity (Towers See Gale, Papke and VanDerhei (1999) for more detail on these trends and a summary of the literature explaining defined benefit and defined contribution concepts include pension equity plans, age expected rate of return on cash balance portfolios difference between the account balance and the highest year of eligible pay is $30,0 in a tax par See Sher (1999, p. 22) for an illustration of how the increasing or decreasing the current 30 ticipant will increase (especially if the interest rate credited to the cash balance account is pegged to the 30 -deferred retirement savings account and earn an average annual rate of return of 8.65 percent, while the will remain significantly greater than the expected interest rate 00 or less. Otherwise, employees -weighted profit sharing plans, -year Treasury bond -year order to comply with these sections in determining the amount of a single-sum distribution, the balance of an Perrin, 1999). 11 the potential causes of this shift as well as the attendant i September 17, 1999. mpact on employers and workers. rate by 1 percent can impact the relative comparisons betwee Treasury bond rate). However if the discount rate increases, the present value of the previous benefit will decrease, employee covered by a final new comparability plans, floor are limited to a cash payment equal to one year's worth of their highest eligible pay, with the rest paid as a monthly -average plan would remain in a terminated vested status and not receive lump -offset plans, new comparability profit n an existing traditional defined benefit plan and a new -sharing plans and target plans (Campbell, -sum credited to the employees. For example, age-weighted pay credits under the cash balance plans and early retirement provisions under the Towers Perin. “The Controversy Over Cash Balance Plans.” Hot Topics. 1999. 14 7 1996). thereby reducing th annuity (Burlingame and Gulotta 1998). cash balance plan. distributions. e wear-away period. final Using both administrative records and worker reports of pension provisions. -average plan. To the extent that inflation and wages are correlated. 11 17 16 13 20 19 10 22 21 18 12 15 14 8 7 2 5 3 4 6 9 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995