Association of Flight Attendants Retirement and Pensions
Retirement Matters
all about pensions
Cash Balance Plans and the Older Worker

Many companies have converted their traditional defined benefit plans to cash balance plans, and many more companies would like to convert their plans. The concern about conversion to a cash balance plan is that the older worker will be adversely affected and will receive less of a retirement benefit than he or she otherwise would receive under the traditional defined benefit plan.[10]

A cash balance plan is a type of defined benefit plan. Typically, a defined benefit plan provides a determined monthly retirement payment for life based on a formula stated in the plan. Usually the formula is based on a percentage of salary or an average of several years' salary multiplied by years of service.

For example, a formula might state that a retiree will receive 1.5 percent of her final salary times years of service. Under this formula, a retiring flight attendant with 20 years of service would receive 30 percent of her final salary in monthly retirement benefits at age 65. All monies in the plan are paid by the employer.[11]

Under a cash balance plan, the employer also makes all the contributions. The amount that will be paid to the worker on retirement is not a determinable sum based on a formula. Rather, the amount will depend on how much the employer contributes to the plan every year and the rate of return on the account.

In this regard, a cash balance plan is similar to a 401(k). A cash balance plan is portable, allowing workers to cart their pension accounts from one employer to another.[12]

Although there are some surface similarities between a cash balance plan and a 401(k) plan, there are several important differences.[13] A cash balance plan is a type of defined benefit plan. A 401(k) plan is a type of defined contribution plan. For the cash balance plan, the investment decisions and risks associated with those decisions are on the employer.

Even though the benefits under a cash balance plan are described in terms of an "individual account," that is an accounting fiction. There really is no individual account, all plan assets are managed, in the aggregate, by a trustee.

A cash balance plan is covered by the Pension Benefit Guaranty Corporation insurance program, which is described in more detail below; 401(k) plans are not covered by the insurance program. Another difference is that cash balance plans must offer participants the ability, within the plan, to convert their account balances to lifetime annuities at no additional cost.[14]

The controversy about cash balance plans is that future benefits are reduced for many workers, especially older workers. Over the last ten years, about 700 companies have converted their traditional pension plans to cash balance plans.

Experts report that most of these conversions have drastically reduced future benefits. Representative George Miller (D-Calif.), a critic of conversions to cash balance plans that reduce the retirement benefits of older workers, estimates that about 8 million current and retired workers have lost about $334 billion in promised benefits.[15] This is because cash balance plans are based on average career earnings, not the average of an employee's highest salary over three or five years that is typical of the benefit formula for a defined benefit plan.[16]

Currently, there are proposed Treasury regulations that would allow companies to convert traditional defined benefit plans to cash balance plans provided that current workers start out with at least the present value of their benefits under the former plan. Future earnings are based on the new formula.

"Anybody with around 12 or more years of service with the company [is] going to get the short end," says John Holz, deputy director of the Pension Rights Center (APRC), a Washington-based advocacy group for workers and retirees. "They could lose as much as half the benefits they were originally promised."[17]

This hits older workers the hardest because they 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 PRC.[18]

Federal pension law prohibits companies from taking away retirement benefits that have already been earned. The problem is that cash balance plans often stop older workers from accruing any additional benefits after the conversion.

For example, assume that the conversion from a defined benefit plan to a cash balance plan occurred when a worker was 50 years old. At the time of the conversion, the worker would be allocated a benefit equal to the present value of his future pension at age 50. It is quite possible though, that the same worker could work for 15 more years without getting any additional retirement benefit. Younger workers, meanwhile, would continue to accrue benefits.[19]

This period of time during which older workers accrue no additional retirement benefit is called the "wear-away" period. Many workers at companies that converted their traditional pension plans to cash balance plans sued the companies, claiming age discrimination because of the wear-away period.

During the Clinton administration, the IRS imposed a moratorium on approving new cash balance plans. On December 10, 2002, the Treasury Department and the IRS issued proposed regulations on cash balance plans addressing the application of pension age discrimination rules to cash balance plans and conversions.

Essentially, the proposed regulations would allow conversions to cash balance plans and provide that, if the regulations are followed, any "wear-away" period during which older workers do not accrue any additional retirement benefit is not a violation of age discrimination laws.

It may be that companies converting to cash balance plans will fashion transition rules that will minimize the effects of "wear-away," but that is not required by the proposed regulations.

There is a comment period on the proposed regulations that closes on March 13, 2003. AFA intends to send its comments opposing the proposed regulations to the IRS and join with Representative Miller and others who oppose these regulations.


Page 6  Plan Termination and The Pension Benefit Guaranty Corporation ð

 

[10]See generally, Elliott, Kenneth R. and Moore, James H., Jr., Cash Balance Pension Plans: The New Wave, Compensation and Working Conditions, Summer 2000.

[11]Kristof, Kathy, Return Eyed for Criticized Pension Plan, Miami Herald, December 22, 2002.

[12]Ibid.

[13] Elliott and Moore, p. 4.

[14]Ibid.

[15]Kristof, Kathy, Miami Herald, Return Eyed for Criticized Pension Plan, December 22, 2002.

[16]Branch-Brioso, Karen, St. Louis Post-Dispatch, Longtime Employees Are Eyeing Treasury's New Pension Rules, February 1, 2003.

[17] Ibid.

[18]Kristof,  Op.Cit.

[19]Ibid.
 
  

© 2003 Association of Flight Attendants, AFL-CIO  All Rights Reserved.