Cash-Balance Plans May Make a Comeback
But now, thanks to the Pension Protection Act and a key court decision favoring cash-balance plans, which are a hybrid of defined-benefit and defined-contribution plans, a number of large organizations are considering them as part of their benefits package.
In the past year, Dow Chemical, MeadWestvaco and SunTrust Banks have announced plans to make cash-balance plans available to employees, while FedEx has expanded its existing cash-balance plan.
Despite the trend, industry observers say most companies are cautiously approaching such plans. Although cash-balance plans were initially viewed as a panacea, particularly for those employers with defined-benefit plans, the past few years of regulatory and judicial scrutiny have taken a toll, experts say.
"Over the past few years, cash-balance plans have been vilified in the press," says Alison Borland, senior benefits consultant at Hewitt Associates. And that might mean it will take some employers longer to adopt such plans, she says.
Cash-balance plans were initially attractive to employers when they came about in the 1980s because they provided many of the benefits of a traditional pension but allowed companies to share the risks with employees.
These plans set up individual accounts based on a percentage of a worker’s salary and interest credits, similar to a traditional defined-benefit plan. However, like a defined-contribution plan, they allow employees to take the benefits with them if they leave the company, a trait much more popular in today’s world, where employees often don’t spend their entire working lives at one company.
The cash-balance controversy began in 1999, when the Internal Revenue Service announced it would no longer issue determination letters for cash-balance plans. This meant that employers no longer could receive assurance that the agency approved of their cash-balance plans.
"The fact that the IRS said it would not review these plans caused many companies to be concerned about offering them," Borland says. "Determination letters are not a sure thing, but they do provide some comfort to employers."
Then in 2003, cash-balance plans got another strike against them when a U.S. district court ruled that IBM’s cash-balance plan violated age discrimination laws. In that decision, the judge sided with employees who claimed the plan’s calculations to pay benefits discriminated against older workers. The case caused a number of companies, including IBM, to freeze their cash-balance plans and offer defined-contribution plans instead.
Despite these events, employers and consultants have remained cautiously optimistic that the courts and Congress would address the issue of cash-balance plans.
"Everyone knew that sooner or later new legislation would have to be passed to recognize the unique nature of hybrid plans," says Jack Vanderhei, a fellow with the Employee Benefit Research Institute and a professor at Temple University in Philadelphia.
That’s exactly what happened with last year’s Pension Protection Act, which was passed into law in August 2006 and gave employers the green light to offer new cash-balance plans without fear of litigation.
That same month, a three-judge panel of the 7th Circuit Court Appeals in Chicago reversed the decision on the IBM cash-balance plan, saying it did not discriminate against older workers. Then, in December 2006, the IRS ended its moratorium on determination letters for these plans, marking a last bit of good news for cash-balance plans.
Just two months after the Pension Protection Act was passed last year, MeadWestvaco, a Richmond, Virginia-based packaging company, became the first large employer to announce it would offer cash-balance plans to new employees in 2007 and transition existing employees to the plan in 2008.
Executives at MeadWestvaco and Dow Chemical, which in July 2007 also announced plans to offer a cash-balance plan to new employees, say the portability of these plans was a big selling point.
"We know that many of our newer employees compare 401(k) matches [before accepting a job], so we wanted to give a benefit that was transparent and comparable, but also was portable if employees leave," says Janet VanAlsten, global benefits director at Dow Chemical, which has 21,500 employees in the United States. The average age of a new employee at Dow Chemical is 25.
Dow executives had been discussing the possibility of offering a retirement benefit plan that would be transparent and portable and that could complement its existing 401(k) plan, but the passage of the Pension Protection Act allowed the company to take the idea of a cash-balance plan more seriously, VanAlsten says.
"Before the Pension Protection Act, we were really limited at looking at defined-contribution plans," she says. "But we felt like we needed to be very thoughtful, so we waited for the Pension Protection Act to pass so that we could really look at cash-balance plans."
Under Dow’s new plan, which is called the Personal Pension Account, new employees will receive annual credits equal to 5 percent of pay plus interest, and they can take the value of their pension accounts with them when they leave the company. Current employees will still be eligible to remain in the company’s traditional defined-benefit plan and all employees have access to the company’s 401(k) plan.
Dow executives believe that offering such a benefit will help the company be more competitive in recruiting and retaining talent, particularly since so many organizations are moving away from defined benefit plans altogether, VanAlsten says.
"While many companies are getting out of defined-benefit plans completely and passing all of the risk on to employees, we continue to share the risk and rewards," she says.
And as baby boomers begin to retire, more companies—particularly those with traditional pension plans—are going to switch to cash-balance plans to use as a selling point for recruiting and retaining employees, experts say.
"Companies that were thinking of getting out of the defined-benefit system will now stay in the system with cash-balance plans," says Ethan Kra, chief actuary with Mercer Human Resource Consulting in New York.
Transitioning to a cash-balance plan could be particularly attractive to companies with over-funded defined-benefit plans, Vanderhei says. Employers have to pay an excise tax on excess assets in their pension plans if they terminate or freeze them. However, if these companies convert to a cash-balance plan, they avoid the tax, Vanderhei says.
Although there are several good reasons for employers to get into the cash-balance game, observers say that it’s unlikely there will be a flood of companies with 401(k) plans switching to cash-balance plans.
"Some companies have moved farther along with their defined-contribution plans, so it’s unlikely they will move back to a cash-balance plan," Borland says. "The door has reopened to cash-balance plans, but I don’t think we will see the same movement into these plans that we did years ago."
Kevin Wagner, retirement practice director at Watson Wyatt Worldwide, believes the adoption of cash-balance plans will increase.
"It’s only been a year since the Pension Protection Act and these deliberations take a long time," he says. "For many of these companies, these investments are worth hundreds of millions of dollars."
In making this kind of decision, employers need to evaluate their business goals and determine whether having a cash-balance plan will help with those objectives, Wagner says.
Most important, companies should not be fooled into thinking cash-balance plans are going to solve all their problems, as many apparently did several years ago, Wagner says.
"Just as defined-benefit plans are not a panacea for all companies, neither are hybrid plans," he says. "It’s important for each company to go through a process and find out what’s unique about the business that requires this kind of plan."