Do Money Purchase Plans suffer from age discrimiantion?

[Guest jbruggeman]

Certain entities have claimed that cash-balance pension plans are illegal because of age discrimination due to the "reduction of the rate of an employee's benefit accrual, because of age." Would this same challenge apply to a Money Purchase Pension Plan? It appears that a Money Purchase Plan has this same age discrimination attribute because the benefit formula is basically the same.

[RCK]

Sure. So do 401(k) plans, nearly all profit sharing plans, ESOPs, etc.

But a qualified plan has to be nondiscriminatory in regards to benefits or contributions, not just benefits. In general, DB plans are nondiscriminatory in regard to benefits, and DC plans are nondiscriminatory in regard to contributions. But age-weighted profit sharing plans are cross-tested to be nondiscriminatory in regard to benefits.

[Guest]

Cash balance plans are DB plans where the accrued benefit, according to the IRS, must be defined as an annuity payable at normal retirement. Each year's cash balance pay credit buys less of a normal retirement benefit because the credit has less time to accrue interest to NRA. Thus, the argument is that the older you get, the less NRB you earn.

MPPs, on the other hand, are DC plans. The law simply requires that the rate of contribution to a DC plan must not decrease on account of age. There is no requirement to convert each year's contribution into an age 65 annuity (which is what gets cash balance plans in trouble). As a result of being a DC plan, virtually all MPPs should have no age discrimination worries.

[Guest]

I disagee a bit with Harry O's statement that "Cash balance plans are DB plans where the accrued benefit ... must be defined as an annuity payable at normal retirement". I don't think they have to be, in fact, most of them probably don't.

The annuity at normal retirement date goes up and down every time the credited interest rate changes. If you define your accrued benefit as the current cash balance, you avoid the "problem". As you know, the IRS never really had a problem with this concept and has been issuing approval letters for years, until the folks who control the Wall Street Journal wanted to adopt one and the editors started a smear campaign. Oops, I forgot, the media doesn't influence, it just reports!

[MGB]

Keith,

You are wrong about there being no requirement of defining an annuity. Cash balance plans must contain language that converts the account balance into an annuity at NRD for purposes of defining an accrued benefit. And, it must be in such a manner that precludes employer discretion (i.e., explicit actuarial factors). This projectionneed not be using the interest crediting rate (e.g., a variable interest crediting rate need not be what is used to project). That means that annual changes in a variable interest crediting rate would not cause the accrued benefit to jump around. Without such language, you do not have definitely determinable benefits.

Your comment that the IRS has no problem with defining the accrued benefit as the account balance is the opposite of all of the information that comes from the IRS. However, that has not stopped numerous plans from attempting this, and they keep ending up in court.

See IRS Notice 96-8.

[RCK]

I agree with MGB.

A reputable plan sponsor who set up a Cash Balance plan, and who got competent advice would realize that what they have is a DB plan (that's what gets them the funding flexibility and the ability to "skim" the investment yields). As such, they must have an determinable benefit at Normal Retirement Date, and therefore a lump sum that will undoubtedly be different from the cash balance. That risk is the price they pay for having a DB plan.

Certainly the transition from a traditional DB plan to a Cash Balance plan is frought with risk, and without significant grandfathering may result in some disadvantaged participants.

RCK

[Guest Hans Moleman]

If the actuarial equivalents are defined as the 30-year Treasury Rate and Applicable Mortality Table, I don't see how that is not a determinable benefit. Just because the interest rate changes year to year does not make it not determinable.

Also, by defining the AE as such, the "whipsaw" effect is eliminated and the participants account balance is their lump sum amount (barring a top heavy adjustment).

[MGB]

Hans,

I agree with you. I was not saying that the AE must be different from the variable rate, I was just pointing out that it "need not be" the crediting rate. (On a related issue, when the two are different, the IRS has been scrutinizing this as not meeting the minimum accrual rules of 411 due to a backloading effect...the additional variable rate credits above the AE rate are not earned in the accrued benefit until granted, which means there will be large accruals in later years when the balances get big.)

[Guest]

I certainly agree that cash balance plans are db plans, but I stand by my statement that the annuity at retirement is permitted to fluxuate.

Lets say I have a cash balance plan the meets the IRS safe harbor by using the GATT rates for AE. (Assume 6%,w/ no pre-ret mort) Lets say I have a terminated person who is 45 years old and has a CB of 1000, his annuity at NRD is 25.10 (1000 * 1.06^20)/127.76 = 25.10.

If the 30-year rate moves to 5% at the beginning of the next year his accrued benefit is now 19.35. (1000*1.06*1.05^19)/138.41 = 19.35.

This is the way most cash balance plans I work with operate and we have receive determination letters for all of them.

I agree you can create some funky scemes that the IRS should be looking into, but the majority of cash balance plans were put in for the benefit of the younger short service employees and were not the big money grab the media wants you to see.

[IRC401]

1. The CB plan that you described has a formula for converting the cash balance to an annuity, which is what enables the plan to pass the definitely determinable requirement. The accrued benefit isn't the cash balance but the equivalent annuity.

2. I suppose that we can get into a debate, but I have never seen the slightest bit of credible evidence that any employer puts in a CB formula for the benefit of short term younger employees. The formulas are put in to benefit the company and have the predictable effect of screwing older employees.

[MWeddell]

Okay, then here's some credible evidence:

http://www.watsonwyatt.com/homepage/us/res...ash_balance.htm

Per this survey, employers who convert from a traditional pension to a hybrid plan (most commonly a cash balance plan) on average save only 1.4%. Most employers do it not to save major $$. I believe another consulting firm came out with similar research results.

In my experience, employers who convert to cash balance plans typically figure that their traditional pension plans, which heavily reward long-service employees to a greater extent then other employees, no longer fit their needs.

[Guest]

IMHO, all the reasons you cite are just lip service. The P&L savings generated by going from a final average pay plan to a cash balance plan are just too irresistable for most employers. In fact, in most conversions I've been involved with the employer has kept a non-qualified final average pay plan in place to wrap around the new cash balance plan. Hmmm . . . wonder why?

In any event, employers should be and are free to set up any plan they want. If employees don't like the conversion they can vote with their feet. I don't believe conversions rise to the level of prohibited age discrimination. Painful? Yes. Illegal? No.

[IRC401]

I wasn't able to link to the survey. My memory is that the survey reported what the Companies' party lines were for doing what they did. No company ever admits that it changed the pension plan because it beleives that its workforce was overpaid. Have any ever admitted that they wanted to manipulate the pension plan in order to improve earnings? Therefore, I don't regard the survey as credible.

[PS: I used to work for one of the 100 best places to work in the US that to this day has never told the truth to its employees about the cash balance conversion and ended up probably having increased costs after they changed the plan in response to complaints or a Wall Street Journal article. The plan did increase the rate of benefit accrual for a mjority of the participants in the plan, and quite possibly 20 employees received increases for every employee that suffered a decrease. On the other hand, the increases were immaterial, and 80-90% of the employees "benefiting" from the change, never stayed long enough to vest. See how easy it is to lie with statements about benefiting younger employees. That particular conversion was illegal only because the employer didn't give out timely 204(h) notices.]

[IRC401]

In case anyone is interested, AT&T's official line (per the 2001 proxy statement) is that the change to a cash balance formula was made because AT&T "needed to remain competitive". Feel free to read into that whatever you want.

[david rigby]

"Feel free to read into that whatever you want."

Gee, do you think that's what they were thinking?