Cash balance pension plans getting traction with smaller employersReprints
Bank of America Corp.'s adoption of a cash balance pension plan in 1985 was the start of the biggest corporate pension plan makeover in decades.
Hundreds of employers, including many of the nation's biggest and best-known corporations, such as Cigna Corp., Hewlett Packard Co., IBM Corp. and Wells Fargo & Co., have followed in the path blazed by the San Francisco-based banking giant.
By 2005, 35% of Fortune 100 companies offered hybrid retirement plans, most of which were cash balance plans, according to Towers Watson & Co.
It is easy to understand why the plans became so popular among employers and employees. Accrued benefits were highly visible, with the benefit expressed as a cash lump sum.
The benefit formula was easy to understand, with the benefit earned each year expressed as a percent of salary, with interest, such as the current 30-year Treasury bond rate, also added to employees' accounts.
The benefit earned by employees was tied to their current salary. That meant shorter-service employees accrued benefits much faster compared with traditional final average pension plans, a key attraction for an ever mobile workforce.
For employers, the plans also were attractive. With nearly all plan participants taking their benefits as a cash lump sum when they terminated employment, employers were able to remove a liability from their financial statements.
That meant if retirees lived longer than expected, or if plan investments temporarily soured, employers didn't face added costs for those participants taking their accrued benefits as lump sums.
In short, “Cash balance plans incorporated the best features of defined benefit and defined contribution plans,” said Alan Glickstein, a senior Towers Watson retirement consultant in Dallas.
But around 2000, the skies darkened for cash balance plans and their sponsors. The plans became targets of numerous lawsuits alleging that the design discriminated against older employees.
Regulators and lawmakers declined to intervene. In that climate of regulatory and legal uncertainty, some plan sponsors froze their plans, while many other employers who had been considering converting their final pay plans to cash balance decided against it. Those employers typically froze the plans they had been offering and instead moved ahead on a defined contribution plan-only approach, typically a 401(k) plan.
But the cash balance plan picture brightened in 2006. That was the year Congress —in passing a broader pension funding bill, the Pension Protection Act — made clear that the plan's basic design would not be considered discriminatory against older employees.
“By saying that these plans were legitimate, the PPA helped enormously,” said Kevin Wagner, a Towers Watson senior retirement consultant in Atlanta.
Near simultaneous with that congressional action was a 7th U.S. Circuit Court of Appeals ruling that IBM's cash balance plan did not discriminate against its older employees.
That ruling was the first of five appeals court decisions, all rejecting the age discrimination charge.
After the congressional and court actions, a handful of very big and well-known employers — including The Coca-Cola Co., Dow Chemical Corp. and MeadWestvaco Corp. — set up cash balance plans.
On the other hand, other big employers, including IBM, Cigna and cash balance plan pioneer, Bank of America, froze their cash balance plans.
In fact, much of the cash balance plan action during the past few years has been in the small to medium-size employer market.
In that market, “There has been a huge appetite for cash balance plans,” said Dan Kravitz, president of Los Angeles-based retirement plan administrator Kravitz Inc.
Research confirms that. In 2009, the most recent year statistics are available, nearly 12% of employer plans with less than 1,000 participants and insured by the Pension Benefit Guaranty Corp. were hybrid plans, mostly cash balance plans.
That's a roughly five-fold increase compared with 2001, when just over 2% of plans with less than 1,000 participants were hybrid plans, according to PBGC research.
“We saw several advantages to cash balance plans,” said Joe Ducey, director of Presbyterian Anesthesia Associates in Charlotte, N.C. “We saw the plan as a way to recruit high quality physicians by setting us apart” from other medical corporations in the area.
In addition, the cash balance plan allows participants to make tax-deductible contribution to the pension plan at a time when their incomes are high, while the participants will be receiving their benefits when they retire are likely to be in lower tax brackets, Mr. Ducey said.