New Cash Balance Plans

[Guest lerieleech]

I used to be up to speed on cash balance plans, but as I have not done any work on them for a couple years, I am rusty.

If an employer is considering establishing a new defined benefit plan, what are some of the most likely reasons why a cash balance plan might be the preferred type of plan over a traditional db plan?

The big one to me is that employees, and sometimes employers themselves, understand the account balance concept better than they do accrued benefits. Another I have read about is that some employers like to have the newer, "trendy" types of plans.

What are some others?

[mbozek]

Before considering a CB plan why not read the comments on the IBM and Xerox court cases which affect the accruals and the valuation of distributions in ways that are incompatable with CB design. If the Courts uphold the requirement that interest credits are part of the accrued benefits which cannot discriminate on account of age there will be no reason for CB plans to exist. There have been threads on these decisions on this message board. Any employer considering a CB plan has to evaluate the financial risk under these two cases.

[Guest lerieleech]

mbozek,

Thanks. I definitely will look at those and take those into consideration.

I do still need to know what advantages there might be to a CB over a traditional DB.

[Blinky the 3-eyed Fish]

Personally, I wouldn't be too worried about establishing a new cash balance plan even in light of recent court cases. But perhaps I am being overly optimistic that people aren't stupid enough to take a plan that conceptually works exactly like a DC plan and deem it discriminatory.

As for the advantages, you are correct that participant communication is one of them. People understand an account balance. They don't understand the value of an accrued benefit.

Additional advantages relate to the small plan world. In these situations a cash balance plan can provide a way to "equalize" groups of individuals, especially in multiple owner situations. This also works well to controll DB costs for older individuals versus younger ones (ah, the ADEA police will get me for that). Also, a cash balance plan can be good at controlling escalating costs that occur within the unit credit funding method as time passes.

If someone is adopting this type of plan to be trendy, tell them to by an IPod instead because that's just silly.

[Guest lerieleech]

Thanks Blinky.

As for the trendy issue, I agree that adopting a CB plan to be trendy is silly. However, I heard about this in an online seminar, so I guess it does happen.

[E as in ERISA]

Final average pay DB plans tend to provide lesser accruals to shorter term employees and larger accruals to long terms employees. A cash balance plan tends to even out the accruals. In a mobile service environment, a cash balance plan may be more competitive in attracting some talent (presuming that they understand cash balance v. FAP).

[SoCalActuary]

As an actuary who finds CB plans useful, let me offer these additional points:

1. Partners like the predictable nature of the promised benefits. They can be certain of the cost allocation between partners.

2. CB plans, like other accumulation benefit plans, don't have the dramatic problems with unexpected liability increase when pay raises are given.

3. CB plans can avoid the dramatic volatility of PVAB values by tying the actuarial assumptions to the 417e rates.

4. CB plans can use DB plan limits in cross-tested plan designs. If the targeted group of owners/HCE's are passing 401(a)(4) easily at 415c limits, then the CB plan is the logical next step to higher benefits.

5. CB plans can easily be amended to offer one-time benefit increases as in the PwC QSERP © programs.

[Blinky the 3-eyed Fish]

So there is no confusion, some (most) of the stated CB advantages in the last 2 posts can also be part of traditional DB plan designs.

[mbozek]

Blinky: what kind of a CB plan would not violate the age discrimination provisions of ERISA which cover all employees (not just those 40 or more)? Given the hostility in Congress to IRS relief for CB plans how can an advisor recommend such a plan? The issue that drives the opposition to CB plans is the reality that CB plans discriminate against the congressionally protected group of older employees who vote for Congress every two years. Xerox settled its case for 240M rather than appeal to the sup ct and IBM has acknowledged discrimination in the pension equity benefit formula for 320M. The only thing left to determine is whether the CB formula discriminates under ERISA for which IBM could be liable for an additonal 1.4B.

[Blinky the 3-eyed Fish]

By arguing that CB plans discriminate against older workers, please tell me how DC plans do not discriminate against these same folks. To say that an equal percentage of pay contribution is discriminatory is just insane to me. It would be like saying that gas cost $2.00 a gallon for younger people, so older people need to pay $1.00 a gallon. Frankly, I just don't understand how the conclusion can be drawn that it is discriminatory. It may be worse than a traditional DB plan for older workers, but you can't say it's discriminatory. The company could have no plan at all or terminate a plan at any time.

I understand that many older workers got the hose when traditional DB plans were converted to CB plans and while I don't think that is necessarily discriminatory, I agree with their plight because of the way some of these conversions were handled. I wouldn't touch a cash balance conversion. But a new CB plan is a completely different story. Maybe if we just called it a Super DC plan, then people would get off this anti-CB kick.

[david rigby]

By arguing that CB plans discriminate against older workers, please tell me how DC plans do not discriminate against these same folks.

Correct. But that is not what the Code says, so the age discrimination arguments go on.

[Guest lerieleech]

Do the same concerns about conversion exist when terminating a DC plan to set up a CB plan?

[mbozek]

Under ERISA age discrimination in a DC plan is limited to the contributions. As the judge in the IBM case noted, the interest credits would not be discriminatory in a DC plan. I don t make this stuff up.

[Blinky the 3-eyed Fish]

Mbozek, I am curious and can't tell from your posts, do you personally think all CB plans are discriminatory? Forget any court cases, I am asking for your opinion.

[mbozek]

While I don't believe that an increase in a DB benefit which is due solely to the crediting of interest over a period of time to a normal retirement age constitutes age discrimination against an older person because there will be a lesser period for the interest to compound than there will be for a relatively younger employee, there is a problem if the interest crediting is included as part of the benefit accrual under the plan formula. There are many scholarly articles which have attempted to define the interest component as either discriminatory or non discriminatory under ERISA and the ADEA because of the effect that interest componding has on benefit accrual for older employees. Truth, like beauty is in the eye of the beholder. I believe that the courts will ultimately find the practice to discriminate on account of age simply because it is the path of least resistance for legal analysis.

[Guest lerieleech]

Somebody told me that the IRS has put ALL determination letter requests on hold for cash balance plans, not just the ones involving conversions.

Is this correct?

[Blinky the 3-eyed Fish]

Not correct. The IRS continues to issue determination letters on all CB plans other than those considered to be conversions.

there is a problem if the interest crediting is included as part of the benefit accrual under the plan formula.

Mbozek, can you elaborate? Unless I am thinking about something different that you are, how does this differ from the earnings in a DC plan, other that the fact that the rate is guaranteed?

[mbozek]

Age discrimination in a DC plan only applies to the contribution made to the employee's account, not to rate of earnings on the contribution. ERISA 204(b)(2)(A). As I understand, it the crediting of earnings in a CB plan formula as part of the retirement benefit discriminates on account of age because the annual benefit accrual for any employee at NRA as an annuity will always be less than the accrual for an employee who is one or more years younger who has the same comp because there will 1 or more fewer years for interest compounding.

Illustration: 2 employees w/50k income are age 35 and 36. Accrual is 2% of comp with 6% interest credited to NRA at 65. Annuity factor is $140 = $1 monthly annuity at 65.

benefit accrual of 35 at 65= 1000 x .06 x30= 5743.49fv / 140= 41.02 mo. annuity

benefit accrual of 36 at 65= 1000 x .06 x29= 5418.38fv / 140 = 38.70 mo.annuity

Since rate of benefit accrual for 36 yr old at NRA is less than the benefit accrual for 35 yr old the formula violates ERISA's prohibition on discrimination on account of age under 204(b)(1)(H)(i). This formula would be not violate ERISA if it was used in a DC plan because only contributions cannot be reduced on account of age.

Note: The benefit accrual would comply with ERISA if the rate of interest for the 36 yr old was increased to 6.21319.

[JAY21]

Blinky, do you have any idea if the "wait time" to receive a FDL from the IRS on a new cash balance plan is the same as for other "customized" (i.e., not Volume Submitter/Prototype) plans of a different type (e.g., a traditional DB plan) ?

[Blinky the 3-eyed Fish]

I don't know for sure but I haven't noticed a difference. For an unscientific sampling, my last CB took 6 months to get a letter.

Mbozek, I understand the concept, but I am just not always sure what you mean by your posts. Now I haven't followed these CB cases closely, but while the IBM case had one view, didn't the Eaton v. Onan case have another?

You say that you think that the courts will find CB discriminatory on the path of least resistence. I however, think they will take the path of least stupidity. Sure there is 204(b)(1)(H)(i), but there is also the existence of cash balance plans through the regs, justifying their existence. But to get back to the basics, a CB plan works just like a DC plan. In the end, whether it be through the passage of additional regulations or attaining a grip on reality, CB plans will prevail to be nondiscriminatory. We'll just have to wait and see though.

[mbozek]

B: While Onan did not find a violation of ERISA's age discrimination provisions, the plan sponsor paid 20M to settle the case out of court which tells me that the er wasnt too confident that it would prevail on appeal. In any event there was no appellate review. The IBM appeal will be heard in the 7th circuit where neither the district ct in Ill and the 7th circuit are receptive to CB plans as the decision in Xerox case confirms. (The opinion in the Xerox appeal was written by Judge Posner who is one of the most intelectually gifted judges in the Fed system). The IRS regs do not control the interpretation of Title I of ERISA by the Fed cts which will look to the legislative history of the Act which clearly draws a distinction between DB and DC plan accrual rules and structually CB plans are subject to the DB rules. There is no way the Congress will approve appropriations for the IRS to issue regs that approve of wear ways and lower benefit accruals for older employees in CB plans since the issue is so politically charged (as IBM found out). The only way for CB plans to prevail is if the courts find that there is no reason to distinguish between DB plans and DC plan benefit accrual rules which is not likely.

[Blinky the 3-eyed Fish]

The opinion in the Xerox appeal was written by Judge Posner who is one of the most intelectually gifted judges in the Fed system

Based on this opinion alone, can I disagree with this statement?

Let's get back to this message when all is said and done. I think this horse is beat.