Conversion to Cash Balance

[Guest Scorpionpenn]

Could anyone out there who knows pic up on this question. Appreciated. If my Company converts to a Cash Balance or similar type of plan what happens to my current 34 years of Service. I am 51 years old and my concern is that the Company will freeze my current "Value" by NOT allowing my age to continue in my current plan till I can receive a full unreduced Annuity which would be available to me at 57. With current age reduction factors I'm only currently eligible for about 35 - 40 % of my annuity (or Lump Sum if I choose). My understanding is that at Retirement commencement, if converted to cash balance, I would "choose" either the 34 years earned under my current plan WITH THE AGE CARRYING ON or the Cash Balance value amount for all Years of Service whichever would be greater. This creates the effect of a wearing away of my current plan (a freeze) if the cash balance plan turns out a lower total value at retirement commencement. Am I correct? Or, would I be "frozen in time" in my current plan with the 35 -40 % value of which then surely the cash balance plan would surpass albeit coming in much lower in value than if allowed to CARRY ON MY AGE WITH MY 34 YEARS IN MY CURRENT PLAN. Thx. Charlie.

[Mike Preston]

*** WARNING: LONG POST ***

It is hard to agree or disagree with what you are attempting to communicate because specific numbers weren't provided. However, it is not unusual to have a "subsidized early retirement" benefit available to you if you continue to work until age 57, but if you calculate your benefit entitlement at age 51 it comes in as 30%-40% of what you would get if you waited until eligible for normal retirement at, say, age 62.

ERISA and the Internal Revenue Code preclude most plans (like one sponsored by a private sector employer) from reducing benefits to which you have already become entitled. If you work for a non-private sector employer, like a governmental agency, ERISA and the Internal Revenue Code don't provide that protection. However,it is a rare situation where a governmental employer will attempt to reduce benefits to which you have already become entitled.

One of the benefits that you have earned is the right to an unreduced benefit at age 57, assuming you continue to be employed until then. This unreduced benefit that you have earned is based on your service through today. You didn't provide numbers, but let's put some sample numbers on the table and you can modify them to fit your situation. I'm going to make some simplifying assumptions, so my calculations may not be applicable to your individual calculation.

First, I'm going to assume that your pension is a flat percentage of your average compensation, multiplied by your years of service. Second, I'm going to assume that your average compensation today is $40,000. Third, I'm going to assume that the flat percentage is 2%. That means that today, you have earned a benefit of $40,000 * 2% * 34 / 12 = $2,266.67 per month, beginning at your normal retirement age. I'm going to assume that your normal retirement age is age 62.

If you were to quit right now, you would be able to wait until you are age 62 and then get a pension of $2,266.67 per month. Alternatively, your plan might provide that you could get a pension starting at an age earlier than 62, but that pension would likely be reduced to account for the fact that you are expected to get it for more years (you are younger than age 62 when you start), and also reduced because you are getting it earlier. The question is at what age your plan allows you to start getting payments if you quit right now? For ease of comparison, I'm going to assume that you can get your pension at the same age that you mentioned above, at 57.

Using some standard actuarial factors (there are many available, so the use of any specific factor in this illustration might not be a good estimate of what your plan provides), if you begin your benefit at age 57, instead of being $2,266.67 per month it would be about $1,500 per month. (For those that want to confirm my numbers, I used the GAR94 mortality table and 6% interest).

However, if you continue to work until age 57, as I understand what you have said, because your plan provides you with a benefit that is "unreduced", you would expect to get a benefit that is no less than $2,266.67. Note that this is probably only provided to you if you continue to work to age 57 with the company.

So, let's attempt to answer what I think your question is, based on the above. If your company replaces your current plan with a cash balance plan, is there an option that you MUST be able to choose which will guarantee that you can receive, at age 57, assuming you continue to work until then, a benefit that is at least as big as what you have already earned ($2,266.67)? The answer is yes.

Now, the company might give you a choice, once the plan is changed. One of those choices might be to convert your current benefit, based on your current age and service, into an opening cash balance, and then to accrue future benefits in accordance with a new formula that is based on a percentage of your pay. If you elect this choice, and you continue to work until age 57, then your benefit from the plan, as modified, might be lower than the $2,266.67 calculated above. If it is indeed lower, then you would still be entitled at age 57, if you decided to retire then, to a benefit of $2,266.67/month.

To recap, if you have already earned a benefit (e.g., $2,266.67 per month) that you can take at age 57, by just continuing to work until age 57, even if your benefit doesn't otherwise go up, then it doesn't matter how the company changes the plan, you must be able to get that benefit if you continue to work until age 57. At least, that is my opinion.

Based on what I've read in the papers, it appears that some companies are attempting to give participants a "choice" of benefits, on conversion, that in some circumstances would result in a lower benefit than what has already been accrued under the plan at the point in time when the plan is changed over to a cash balance plan. I'm a bit skeptical of that actually happening, because ERISA and the Internal Revenue Code prohibit that sort of reduction, in my opinion. Every case I've investigated on behalf of a participant (I've done it three times, I think), the plan is not reducing what has already been earned, but instead reducing what the participant might have earned in the future. ERISA and the Internal Revenue Code protect what has already been earned. They do not protect the right to earn more benefits in the future. Or, stated a different way, a company does not have to offer a pension plan. If they choose to offer a pension plan, once benefits are earned, they can't be reduced. But any benefit that might be earned in the future can be eliminated by the company terminating the plan.

Let's extend my illustration above. Using the same formula as above, let's look at what the benefit might be if you continued to be employed until age 57. In addition to the 6 additional years of service, let's assume one other thing changes - your salary. Let's assume that you get 6 pay raises between age 51 and 57 so that your average pay increases from its current $40,000 to $48,000. That is a little more than 3% per year.

Recaculating the benefit you are expecting to get at age 57 it is:

$48,000 * 2% * 40 / 12 = $3,200.00 per month.

Many people seem to feel that the company is unfairly reducing benefits if they modify their plan to provide for a benefit, in this case, of less than $3,200 per month at age 57. That simply isn't true, in my opinion. If the company were to terminate the plan today, the benefit that is earned through the date of termination ($2,266.67/month payable at age 57, but only if the person continues to be employed until age 57) must be provided. But there is no requirement to provide a benefit that would have been earned ($3,200.00/month payable at age 57, assuming the actual salary increase mentioned).

The logic of the prior paragraph is also extended to plan changes and conversions. It isn't limited to plan terminations. If a company modifes or converts their plan (such as a formula change or a full blown conversion to a cash balance plan), they are not required to provide benefits as they might have been earned under the unmodified plan to existing employees. They are only required to guarantee that benefits already earned are not reduced or eliminated.

I hope this answers your questions.

If not, please post back. This is a very timely issue and it is therefore a very important discussion.

[Guest Scorpionpenn]

Mike, Thank You for your reply. It indeed answered my question. I believed, to use your provided example numbers, that my "$ 2,267.67" would be protected. Thx again.

[Guest jdubya]

Great Info Back from Mike Preston! I appreciate your effort!

After 29 years of a defined benefit plan (highest 5 years salary x percentage per year of service), my company converted to a cash balance plan in 1998. I was given the choice (because I had over 25 years) of keeping the defined benefit plan at a "frozen" 1998 level ($300K value), or moving to the new cash balance plan ($89K value at that time). Since I was 54 in 1998, and only 4-6 years away from retirement age, I stayed with the DB plan.

I have several questions:

1. Definition of "frozen"? Should both the 1998 value and my 1998 longevity be frozen even though I continued to work 4 more years, or should just the 1998 value of the highest 5 years be frozen?

2. Isn't denying me access to the additional cash balance contributions accrued under my name a form of "age discrimination" since other younger people to accrue while the older folks don't? I should note that even though I selected the DB plan, my company foolishly sends me quarterly summaries for my cash values, showing how much I'm missing out on. (now up to $188K value).

Could you provide answers for me or direct me to the right statutes or rulings? Are there good attorneys that will fight this type of discrimination?

[Mike Preston]

jdubya,

Sorry about the delay, things have been pretty busy.

Your post is a bit on the pointed side and asks some questions that would require a lot of space to fully respond to.

In brief, under ERISA your longevity can be frozen as can your average compensation used to determine the benefit at the point in time that it was frozen. However, the value of your benefit must increase to reflect the time value of money.

The age discrimination issue is a major hot-button these days. It can be argued both ways. Not what you wanted to hear, no doubt. I'm one of those that believes it is not age discrimination to freeze a benefit (or, in your case, to define a floor benefit beneath which a newly defined benefit can not be less than).

Good luck.

[Guest jdubya]

Thanks Mike!

Two more questions... my former employer offered me a 'frozen' DB pention in 1998, but being only 53 years of age I chose to defer that pension. Now at 58, after being 'downsized', the company says that only the annuity option was 'frozen' but the lump sum option would be decreased because their actuary tables say I won't live as long. They have not, to my knowledge, applied any increase in the value of money that might have been earned.

Question 1: Is the practice above legal or even morally fair?

Situation 2 - I was receiving an earlier 5+5 early retirement pension from my previous Bell System employer, which amounted to about $12K per year X 8 years (1990-1998). That pension was then bridged with my current telco employer's pension, and the appropriate funds transferred to the new pension account. I stopped receiving my $12K per year at that time.

Now my 'frozen' pension employer (employer #2) tells me that the lump sum value of my pension is being reduced by the original value of the earlier pension I had received (~$100K over 8 years) and that reduction must be adjusted upward for what the value of that $100K would have been if I had not taken it.

Question 2: Is the above legal or actuarily correct?

Thanks, In advance, for your answers!

jdubya

[Mike Preston]

jdubya, it really is impossible to answer your questions without a lot of detail that you haven't provided. I know this stuff is frustrating for you, but unless you have complete information available, asking questions like whether something is morally right or fair is, in itself, not particularly fair.

To start, you need comparison numbers. With respect to question 1, what was the lump sum you could have taken at age 53? That might be zero (if you weren't eligible at that age to receive a lump sum). If you weren't eligible to receive a lump sum at age 53, did the plan estimate what your lump sum would be at a later age? Say, age 58? If so, what was that estimate? What was it based on? How does that number compare to the lump sum you say you are being offered now?

You obviously have some pretty complicated issues to deal with, such as a prior early retirement subsidy and then re-employment with a successor entity that then froze the existing plan. What you haven't said is what the level of retirement benefit the new entity is offering you. If I understand you correctly, you started employment there and gave up your then $1,000/month pension. Was that required? Could you have maintained the pension while still going to work for them, or was it mandatory to stop receiving the pension once you were re-employed?

In order to answer your second inquiry it would be necessary to know what you were entitled to, in technical terms. What was your Normal Retirement Age pension that you had available to you under the plan? What was your Normal Retirement Age? To what extent was the $1,000/month you were getting an "increased" benefit provided to you solely because you took advantage of the "5+5" option from your prior employer? What were you really presented with as options when you stopped your pension in 1998?

You are not likely to get satisfaction from continuing this discussion here. If you think that something improper has been done, you need to engage a local attorney to help you sift through the issues.

Good luck!

[mbozek]

Jdubya: The statute of limitations for making a claim for benefits against the plan could have expired since the s/l for bringing a claim for benefits under ERISA is the same period as would apply under equivalent state law. In some states 5 years would be beyond the s/l for a contract claim. You should also review the waiver of rights that you signed when you left employment. You may want to retain counsel to review the issues and determine the s/l but you will have to pay a retainer to the attorney.