Learn What's Hot in Portable Pensions
Look carefully. Does your company pension plan fit your work force? If not, you might want to consider some of the newer ideas in pension plans—the most popular of which is the cash-balance plan. (For other pension ideas see "Variations on a Theme: More New Ideas in Pension Plans".) The cash-balance plan features a "phantom" or "hypothetical" account balance for each participant so that employees see what their account balance is each year, just as they would see their growing benefit in a defined-contribution plan or 401(k) plan. But the cash-balance plan is more secure for employees, because the employer contributes the money, invests it and assumes all the risk while still promising a "defined benefit" that an employee can count on down the retirement line. Because employees can see what their benefits mean in today's dollars—they may keep their attention on you, the employer, longer than they otherwise might.
"The old pension plans were designed to reward people for long and loyal service, and that's really changed a lot," says Lindsay Wyatt, editor of Pension Management magazine in Atlanta. "Now the purpose of pension plans seems to be to provide a competitive necessity. In other words, companies need them to attract and retain qualified employees."
And cash-balance plans, for some employers, are fitting that bill. "Cash-balance plans are very hot right now," says Allen Steinberg, a consultant with Hewitt Associates in Lincolnshire, Illinois. Statistics certainly point in that direction. According to estimates by New York City-based Buck Consultants Inc., more than 100 U.S. companies have them. And the number is growing.
Why the popularity? Although a cash-balance plan basically is a hybrid of the traditional defined-benefit plan, "It offers some advantages over the traditional defined-benefit plan from the standpoint of the younger employee," says Wyatt. One of the primary advantages is its portability. People can take their cash-balance pension money with them in the form of a lump sum when they leave an organization—whether they're 25 or 65. "I think people generally are looking for portability—benefits they can take with them from job to job because it's very rare anymore for a person to spend an entire career in one job," says Wyatt. "It isn't as cut-and-dried as a regular defined-benefit plan that requires an employee be at the company when he or she retires to get the benefits."
Adds Wyatt: "People also are looking for incentives, such as company-matching funds." To be sure, 401(k)s are perhaps the most popular of money-saving ideas among employees for just this reason. But employers, realizing that workers need more than one nest egg to survive in their retirement years, also realize that they can only attract the best employees by offering more than one savings vehicle. So, they often elect to offer another type of a pension in addition to their 401(k) offerings.
Cash-balance plans are a good addition because they can cost employers less to administer. "There are features in the defined-benefit plans that are still popular to large employers," says Steinberg. "But cash-balance plans tend to have more modern formulas, so they tend to be less expensive to maintain than your traditional defined-benefit plan." The typical formula for crediting each employees' account is X% of annual pay plus Y% in interest credit (usually based on a published index such as the prime rate or a one-year, T-bill rate).
And cash-balance plans may be less of a hassle to administer because they don't have multiple investment options or employee contributions. Neither do they require recordkeeping for actual individual accounts. Also, because employers retain control over the trust fund and investment strategy, they can invest aggressively and make lower cash outlays.
Steinberg adds: "And employees like [cash-balance plans] more than traditional plans. It's tough not to seriously consider one at this point."
Take a good look at your employee population.
So, let's consider it. But, you say, I've already got a pension plan. OK, but does it fit your work force? "One reason why companies want to look at a cash-balance pension plan is that they already have a pension plan, but they feel it isn't appreciated by the work force because of a high-turnover environment," says Daniel H. Carlson, a benefits consultant for Buck Consultants Inc. in Chicago. Typically, a cash-balance plan will reward short-service employees more than a traditional defined-benefit plan.
That's because, according to Carlson, employees younger than 45 typically will accrue more in a cash-balance plan than they would in a regular defined-benefit plan—whereas older, longer-service employees don't receive as much economic value from this type of plan.
"If you believe your work force to be predominantly young and predominantly short-term—not full-career (less than 30 years), but 10 years or fewer—the benefit of a cash-balance plan to them will be greater," says Carlson. "But if you were to compare the cost of [funding] that cash-balance plan to the cost of a traditional defined-benefit plan, using the exact same demographics, you will find that your cash-balance plan might cost you more. So you might have to play with that." While funding a cash-balance plan might cost more in the short-term, it may be worth the investment based on your goals.
The bottom line is it depends on who you're trying to reward—and for what. In a traditional defined-benefit plan, you aren't making a contribution or crediting accounts until workers reach those longer-service years. "You put in just a little money in their early years, betting they're not going to be around to get the big contributions later on," Carlson explains. In a high-turnover employment environment in which the bulk of workers are young or short-term, you'll find the cash balance idea more appealing to those workers. And although it may cost you more, it still may be worth your while to change pension policy if you're getting low mileage out of your old defined-benefit plan anyway.
Just how easy to understand is a cash-balance plan anyway?
Getting high mileage out of any plan requires that the workers for whom it's designed understand its value. "One of the big issues still remains the ability to communicate pension plans effectively to employees. A plan doesn't work unless the employee understands it," says David Wray, president of the Profit Sharing/401(k) Council of America (PSCA), based in Chicago. "Plans that are difficult to communicate, even though they might theoretically have a lot of benefit, sometimes have problems. It's all about education and communication. That's where the most creativity and the most effort for doing new stuff is going right now."
Therein lies another advantage of a cash-balance plan—it's easier to comprehend than traditional defined-benefit plans. "Employees like it more because they see a number they understand," says Steinberg. In a cash-balance plan, each participant's account receives contribution credits and interest credits. A contribution credit typically is a percentage of pay. An interest credit is an interest rate applied to the beginning balance. Typically, that interest rate is tied to some market index, usually treasury bonds.
Stamford, Connecticut-based Xerox Corp., for example, credits all eligible employees' accounts each year with 5% of their annual pay and one year treasury bill plus 1%. "We think that the concept of individual accounts is very attractive to our employees," says Patricia Nazemetz, director of benefits for Xerox. "We really think we wouldn't have enjoyed the same level of employee satisfaction if we went to a straight defined-benefit plan."
That's because the benefit is simple to understand. "Each year [employees] see a number which says that their benefit is worth this many dollars. Their accrual formula is X of their pay, plus Y dollars in interest credit. To a 25- or 30-year-old, that has meaning and substance," Steinberg adds. Compare that to communicating a traditional defined-benefit pension formula. "You go to that same individual and you say, 'OK, you accrued another 1% of your final average pay, times service beginning age 65,' and they look at you like, so what?" says Steinberg.
With traditional defined-benefit plans, employers send out statements that say your benefit at age 65 will be a certain number of dollars. "If you state a pension benefit to someone who's far enough away from retirement, that's a pretty irrelevant promise," says Steinberg. He says that most people don't appreciate the annuity value of pension plans. An annuity is an amount that's paid to you every year for the rest of your life. That's too abstract a concept. "I always joke that people are genetically incapable of understanding defined-benefit plans until they reach age 50. When they reach 50, there's this gene that clicks on and suddenly they appreciate them," quips Steinberg.
Although you can tell an employee that they're going to get X number of dollars each year at age 65, the problem is, they typically don't expect to still be working for you at age 65. "So for lots of reasons, that promise is so heavily discounted in their minds, it isn't well understood. As a result, it tends to have very low value," Steinberg says.
That was exactly the problem San Francisco-based BankAmerica Corp. was having in the mid-'80s. The company had a final-average pension plan that few employees understood. "The problem was low employee appreciation and not really understanding how the plan worked—particularly among young employees. They had no clue," says Ray Allsup, VP/benefits planning consultant for Bank of America in San Francisco. The company currently employs more than 90,000 workers, of which 60,000 are eligible for the pension plan.
Besides being virtually indecipherable, B of A's former pension plan was inadequate for the company's mid-career employees (those who would work 20 years for the organization, then leave). "Those individuals took a major hit in terms of their benefit from the final-average pay plan," Allsup says. "We were looking for something that would add value for a young work force and something that would add value for people who go in and out of the work force—that is, those who come to work for B of A for a few years, go away, come back, and so forth—the mobile work force. We were looking for a portable pension."
The solution, suggested to B of A by Fort Lee, New Jersey-based Kwasha Lipton, was the cash-balance plan it implemented in July 1985. In fact, B of A was the first large U.S. employer to adopt such a plan. "We were very successful with it. We got a lot of employee appreciation for the accruals under the pension plan—for the first time ever, basically," says Allsup.
The cash-balance plan also has been good for B of A because of the highly tumultuous market it's in. In 1985, executives predicted that there would be a tremendous amount of buying and selling of businesses in their market. And, they predicted high work-force turnover. Their predictions came true. In that type of environment, employees don't always come out ahead if they're near retirement and the business in which they work is sold. "The cash-balance plan helps ease some of those transition issues," says Allsup.
Do employers such as B of A make a special point of promoting a cash-balance plan to fast-track employees? "They're usually not that overt in trying to identify this as a better benefit than the old plan for fast-track and short-term employees," says Carlson. What employers typically promote instead is the understandability of the program. "Everybody is used to using a checking account and a savings account, and all of a sudden, they see the money going in and they're getting some interest for it. That makes sense to people. They can understand that," he says. "This is a feature of a cash-balance plan that you wouldn't see in a defined-benefit plan."
He adds: "It's all in how the plan has been communicated to employees. The employee sees it as a savings account earmarked for retirement that grows with contributions and interest credits. Because it's in a pension plan, really what it is, is a growing, accrued benefit that gets paid at age 65. But even that monthly pension paid at age 65 has value in today's dollars. That's what is shown as a cash balance or the account balance."
In most traditional defined-benefit plans, employees don't know what their take of the pie is—until they retire. There are no calculations made on an individual basis, because an employer usually pools the money and invests it as one large sum—usually in stocks and bonds. With cash-balance plans, as in traditional defined-benefit plans, the advantage for employers is that they can invest all the pooled assets, and plan sponsors can take on more risk over the long term and hopefully generate higher returns. Yet, they can limit the credits to employees' accounts with a fixed interest rate. In time, if a company's investment returns on the assets exceeds the interest credits given to plan participants, employers can reduce their contribution to the plan. "It can lower their costs," says Carlson. And from employees' perspectives, it's risk-free.
Giving employees readily available pension information helps promote understandability and can boost retention.
Many employers who have adopted cash-balance plans offer employees a periodic statement of their accrued benefit, usually quarterly or annually. Xerox, for example, sends employees a statement once a year that lists the value of their cash-balance pension benefit (annuitized benefit) in addition to their allocations in the company's profit-sharing plan, 401(k) and employee stock-option plan (ESOP). The rest of the year, Xeroxers have access to their account balances 24 hours a day through the company's voice-response benefits system, called "Xerox Facts."
This is part of Xerox's overall effort to focus employees' attention on preparing for a strong financial future. In addition to traditional handbook communications on benefits, Xerox also makes available to employees an investment kit called "Pathways," which includes a video and a workbook. "It talks about what role the cash-balance plan plays in preparing for a secure financial future, what role Social Security plays and what role savings plays—be they accounts through the company or private," explains Nazemetz. "That really brings people to do workbook calculations around the what-ifs, such as 'Will I have sufficient money to retire?'"
Although giving employees more access to this information is seen as a huge benefit to workers, it can prove more costly to employers. "It takes a lot of time and effort to calculate those benefits every year," says Carlson. "Whereas with a regular defined-benefit pension plan, the only time you have to calculate the benefit is when employees need it." That's usually upon retirement.
But you can control some of these costs based on your needs. B of A has scaled its communications process down in the past few years from elaborate benefits communications seminars to simply sending out benefits statements every quarter. The organization still enjoys a high-level of understandability about its pension plan and shorter-term employees like it more because their benefits are accelerated in comparison to regular defined-benefit plans. "We had to [scale down our communications] because of the pressure to reduce costs throughout the organization," says Allsup.
But HR frequently has another pressure when it comes to pension plans: showing top management the link between the plans and retention. B of A, for one, doesn't bow to this pressure and doesn't even try to make that connection. It has severed the link between retirement and eligibility in its pension plan. "While we want to continue to educate our employees in terms of financial planning, we try not to have any hooks so that an employee feels compelled to work longer with the organization just because of the pension," says Allsup. He says that the pension plan does aid retention in that if the firm didn't have the cash-balance plan and the 401(k), employees, when they reach the age of approximately 45, might migrate away from B of A.
Under the organization's old pension plan, employees had to reach certain milestones to be eligible for certain pension benefits. One of the features of the cash-balance pension plan is that it usually allows plan administrators to add a "front-loading" factor into the plan's formula. (Traditional defined-benefit plans are usually "back-loaded" providing greater benefit accruals to older and longer-service employees.) "It puts more money up front and evens out your accrual throughout your career," explains Allsup. "So, employees should basically be indifferent. They can work for B of A early, late or any part of their career, and they're going to earn a fair retirement benefit."
The rewards you can reap from possibly lengthening an employee's tenure with your organization, simply through the clear communication of employees' benefits programs, can be enormous. But employers aren't only getting better at communicating their pension plans; they're getting better at communicating their business strategies overall. And that's good. "A pension plan, like all your other benefits plans, sends a message about the kinds of behaviors you want people to engage in, about who you care about, what you as an organization want to encourage and don't want to encourage, and where you're going as a business," says Steinberg. "I think employers are much more concerned about communicating the business direction, the business needs. And to the extent that the pension plan is consistent with where the business is going, in effect, the plan sends that message."
It's a movement toward overall strategic communication. "Companies are attempting to integrate their retirement plans into their overall human resources strategies more than ever," says the PSCA's Wray. "Several years ago, you'd have found that a lot of pension plans were very vanilla. There was relative similarity from company to company. But as we go along, the whole retirement approach really is starting to be customized."
Experts say it's really an issue of figuring out who's important to you and what you're trying to reward in the business and then using the plan in a way that's consistent with that. You don't want to send a set of inconsistent messages through your array of benefits programs.
In the end, will you get what you reward? If you reward employees for short-term service, does that make workers blind to the benefit of staying longer? "I don't think you build the kind of employee you're going to hire based on your pension plan," says Carlson. "What you do is look at the kind of organization you are and the business goals of the company, and determine the type of pension plan that better fits that philosophy."
So, while you may not be privy to the latest music bands or tunes, at least you can consider what kind of retirement language will help tune your mobile work force in to your company's goals. A cash-balance plan may be just the kind of pension plan that will be music to their ears.
Personnel Journal, October 1995, Vol. 74, No. 10, pp. 34-42.