accrued benefit under cash balance plan

[Gary]

a cash balance plan provides in its definition of ab, that the ab be based on the cash balance at determination, divided by 200 and payable as an escalating annuity (i.e. built in cost of living adjustment)

the above seems to violate 96-8, in that it appears to be a backloaded cash balance plan (i.e. no automatic interest credits to age 65).

the ab also says that the age 65 benefit is based on the cash balance at current date projected to age 65, divided by 200 and payable as an escalating annuity.

so there seems to be a contradiction here. in one sentence they imply that the ab is the current balance divided by 200 and payable at age 65 (but do not explicitly say this, but their participant benefit calcs support this). and in the next sentence it seems clear that it is saying that the balance is projected with interest to age 65 then divided by 200 (which would be consistent with 96-8).

i see the above definition of ab as meaning that a COLA is part of the ab and when determining a lump sum it s/b part of the ab and included.

the plan also says that the normal form is a 5 year c&c.

the plan also says that as an optional form of payment the participant can convert the 5 yr c&c to an escalating annuity, thus implying here that the benefit is not automatically paid as an escalating annuity. or at least that the ab does not include the cola. what they do on their benefit calc is to use current balance divide by 200 (with no increse for interest) and say that s/b paid as a escalating annuity.

there seems to be inconsistent language.

it appears that a lump sum s/b the pvab where it is based on a 5 yr c&c with a automatic cola.

any comments?

[Guest Brian4]

Some questions to help clarify the situation:

1. What is the escalation factor used to increase benefits?

2. About when was the cash balance feature added to the plan?

[Gary]

the cash balance feature has been in the current plan (which includes mergers of other plans that already had a cash bal feature) since 1/1/92.

they define the escalating factor based on a couple of indices (not related to 96-8), with a minimum of 4%.

however they have added an ad hoc amendment to the plan every year since 1992 to have the interest credit and COLA be 8%.

they also say when determining a lump sum the balance is increased at the PBGC rates (just like they use to discount the lump sum from age 65). in other words they use one definition to increase the balance when the payment is an annuity (or no increase at all) and another increase factor for a lump sum option.

i don't know off hand what the indices for computing the increase factor are tied to off hand.

[Guest Brian4]

The automatic cost-of-living increases accrued by active participants in pension plans are generally considered part of the accrued benefit, and hence are subject to the anti-cutback rule. This is supported by court decisions. Also, the IRS requires that lump sum calculations reflect these increases.

So, perhaps the plan reference to the accrued benefit includes the increases. Or, perhaps the drafter wanted to be vague, and hence try to limit the ability of participants to make a claim for future increases, claim "whipsaw", etc.

If the benefit increase rate is set equal to the interest rate for lump sum calculations, then the lump sum would be the benefit at retirement age times the life expectancy at that age. In other words, the interest rate discount exactly offsets the increase rate, so there is a constant factor for the conversion of the life expectancy. A factor of 200 for monthly payments is the same as a life expectancy of 16 years and eight months.

However, this type of approach for defining the conversion factor has issues of concern. It was used for at least one early cash balance pension plan. But, this likely pre-dated the interest rate restrictions originally imposed by Retirement Equity Act of 1984, and revised by GATT. Also, it is based on allowable cost-of-living plans, and the index factor often exceeded cost-of-living increases. Could the plan even pay the escalating benefit, under the minimum distribution rules? Note these rules may have been proposed after the plan's formula was adopted.