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IN LOOKING AT A NEW participant-directed cash balance pension plan sponsored by NationsBank Corp. -- now known as Bank of America -- we're reminded of the old saying, "You can't have something for nothing."
It is, to be sure, an intriguing plan. As we've reported, the plan allows participants to direct cash balance pay credits to as many as 11 investment options. An employee's cash balance plan account will then be credited with the rate of return earned by the funds he or she has chosen. If the funds have negative returns, employees still will receive their pay credits.
Similarly, employees had a one-time opportunity through June 28 to transfer to the cash balance plan pretax contributions they made to NationsBank's 401(k) plan. As will the pay credits, an employee's 401(k) monies will be credited with the rate of return of the investment options that employee selected. The company guarantees that employees never will end up with less than the amount they transferred from the 401(k) plan.
Sounds good, doesn't it? Potentially, employees can earn a much higher rate of return on pay credits compared with traditional cash balance plans, where the interest rate credit is fixed but also is typically very low, such as the one-year Treasury bill rate plus 1 or 2 percentage points.
Similarly, the 401(k) transfer feature also sounds like a good deal for employees. Employees' principal is guaranteed, and they need not worry about the downside of investments with above-average risk.
All these transactions, though, are just on paper. In fact, NationsBank doesn't have to invest cash balance pay credits or the transferred 401(k) account balances to the investment options selected by employees.
Because the cash balance plan is a defined benefit plan, NationsBank has the right to invest those contributions as it sees fit.
While NationsBank won't discuss the matter, those who have studied the plan and plan documents say NationsBank believes its actual investments will earn a higher rate of return than the options selected by employees. And that, in turn, will mean lower future pension contributions by NationsBank.
That is perfectly proper and legal. Indeed, employers, through their professional advisers, want to maximize -- so long as it is done prudently -- pension plan investments so that sufficient assets are available to pay for future benefits.
But while NationsBank's pension arrangement may be legal, that doesn't mean it is right for other employers and their employees.
The conventional wisdom is that defined benefit and defined contribution plans are very different programs, the former providing a secure, predictable benefit and the latter allowing employees to earn -- if they are willing to assume the risk -- above-average returns.
Is it good retirement policy to have risk in both types of plans? While perhaps not advertised as such, the participant-directed pension plan does transfer risk to employees.
Those employees who select riskier investment options could end up -- depending on the results of those options -- with just their cash balance pay credits and their transferred 401(k) funds. That may not be enough for employees nearing retirement, especially because NationsBank's pay credit schedule currently appears to be on the low side.
Similarly, a low pay credit schedule means employees choosing fixed-income investment options also may not fare as well compared with participation in traditional cash balance plans with more generous pay credit schedules.
And there is risk for NationsBank as well. With the downturn in the equities market, the benefit guarantees it is providing employees could prove more costly than expected.
Given the pros and cons of this pension program, other employers should look at this approach very carefully and consider the risk to themselves and their employees before deciding to emulate NationsBank.