Pension Equity Plan: Distributions

[Guest wwest]

PEP plans are hybrid plans. What general rules apply to withdrawals and distributions for tax purposes? (i.e. pre-59 1/2 withdrawal)

[Larry M]

A PEP is a form of cash balance plan, which, in itself, is a form of a qualified defined benefit plan.

Therefore, all the rules pertaining to a qualified defined benfit plan apply as well to the PEP.

[Dowist]

Careful.

"Pension Equity Plan" is also another term that is sometimes used for a nonqualified plan (a top hat plan) that provides benefits to highly compensated employees that can't be provided under a qualified plan. It is "equitable" because it results in highly compensated employees getting the same benefits as nonhighly compensated employees when you put the two plans together. It all depends upon your perspective as to whether it is truly equitable.

A nonqualified plan is not subject to the tax rules - no pre-59 1/2 withdrawal penalty for example.

[david rigby]

I don't agree that a "pep" is a non-qualified plan, but this may be merely a difference of terminology.

The more recent use of "pep" is as a hybrid plan. To oversimplify, a "cash balance" plan is a hybrid plan that is analogous to a career average pay DB plan, while a pension equity plan is (usually) a hybrid plan that is analogous to a final average pay DB plan.

That is, the "hybrid" concept is still there, but the underlying plan benefit is more related to a final average pay than to a career average pay. Of course, it is possible to have a benefit that falls somewhere in between.

Is my synopsis OK?

[richard]

I agree with Pax.

A pension equity plan (a term coined by Buck Consultants and/or Segal Company about ten years age) is a final average pay DB plan. The benefit is defined as a lump sum equal to X% of FAP times years of service (compared to the traditional DB plan where the benefit is a life annuity equal to X% of FAP times years of service).

This type of plan (life cash balance plans) is a DB plan subject to all payment rules (age 59-1/2, J&S, etc.)

If, however, the plan being referred to is a nonqualified plan, there are no payments rules.

[Dowist]

Question: Why does Buck or Segal call it a "Pension Equity Plan?" Sorry to those who coined the term, but it doesn't seem to be a very descriptive name. Is it more equitable than a traditional db plan, or than a cash balance plan? What's equitable about it?

[Larry M]

Why the name "pension equity plan"?

If I were a guessing person, I might opine the reason is because Kwasha was using "cash balance plan" and Segal (or Hewitt) wanted to sell something different.

..or it might be something simpler, such as the individual who finally put it together was named Pauline Ethel Pavlov and, just as IRA's were named, so was PEP.

[richard]

Now I never said that it was "equitable." (chuckle, chuckle)

By the way, I haven't heard about many of these pension equity plans. Sounds like the cash balance (i.e. career pay) plans have taken off while the pension equity (i.e., final pay) plans haven't. So much for replacement ratio-type retirement planning.

I wonder if there will be, in the future, final-pay type "updates" on cash balance accounts.

Remember the concept with traditional career pay plans. A plan sponsor would like the idea of a final pay plan but didn't want to commit to it (pay inflation risk, for example). So every five years or so, the career pay accrued benefit was "updated" based on the current final average pay, and future accruals were based on career pay. The concept made sense both then and now; I wonder if this will ever be applied to cash balance plans in the future.

Any thoughts.

[david rigby]

A few thoughts.

You are right in your observation about cash balance vs. pep. My observation is that the latter does not provide as much (if any) savings to the employer, so it is not as attractive. Simple reason.

Traditional career average DB plans were very easy to "update" assuming that the cost was acceptable. The advantage to the ER is that the cost of this type of plan is more manageable and that the cost of an update can be determined actuarially in advance. Knowing your cost pattern seems to be something that CEOs and CFOs like. Surprise.

Cash balance plans can also be updated, although I've not seen one in practice. Anyone willing to share an actual experience of this?