Approved by the IEEE-USA Board of Directors
16 Nov. 2000

Cash balance pension plans are attractive to younger, short-tenured workers because they routinely permit the transfer of earned benefits to other plans or to IRAs when workers change jobs. But, there may be serious financial consequences for older, long-tenured workers when their employers convert from a traditional defined benefit plan to a new cash balance plan.

Employers are currently required to provide a written notice to plan participants when an amendment to an existing pension plan will significantly reduce the rate of future benefit accruals for any active plan participants. Employers can easily meet this disclosure requirement by sending participants a summary description or a copy of the plan amendment 15 days before its effective date.

Additional information about plan amendments is necessary, but not sufficient, to safeguard the financial interests of mid-career and older plan participants who may be adversely affected by conversions to cash balance pension plans. Absent some kind of transitional relief, the impact of a conversion from a conventional final-average defined benefit plan to a new, career-average cash balance plan may be extremely detrimental to long-tenured workers.

Some older workers are likely to be hit particularly hard. They may lose a more generous defined benefit accrual formula at a time when their advanced age will prevent them from earning a comparable benefit under the new cash balance formula.

Policy Recommendations

IEEE-USA recommends that employers minimize confusion and reduce or eliminate the potentially adverse effects of cash balance plan conversions on long-tenured workers by:

1. Providing a clear, understandable and timely disclosure of the effects of plan changes on future benefit accruals and employee choices;
2. Permitting long-tenured plan participants the choice between remaining in the old plan or receiving an equivalent pension benefit under the new plan;
3. Offering compensation to long-tenured workers with supplemental pay credits, interest credits or more generous opening account balances for financial losses they would otherwise incur under the new plan;
4. Retaining the financial incentives for early retirement and other retirement-type subsidies that are often included in traditional defined benefit plans; and
5. Using conversion savings to improve other employer-sponsored retirement savings or retiree health benefits programs.

This statement was developed by the Engineering Employment Benefits Committee of the Institute of Electrical and Electronics Engineers - United States of America (IEEE-USA) and represents the considered judgement of a group of U.S. IEEE members with expertise in the subject field. IEEE-USA promotes the careers and public policy interests of nearly 230,000 electrical, electronics, computer and software engineers who are U.S. members of the IEEE.

The Institute of Electrical and Electronics Engineers, Inc.-- United States of America
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Phone: 202-785-0017, Fax: 202-785-0835.

BACKGROUND ON CASH BALANCE
PENSION PLAN CONVERSION PROBLEMS

The steady increase in the number of employers who are converting traditional final-average defined benefit plans into new career-average, cash balance plans is raising many questions about the advantages and disadvantages of the new plans and serious concerns about the potentially adverse effects of the new plans on future benefit accruals by older, long-tenured workers.

A cash balance plan is a "hybrid" that shares some characteristics of defined benefit plans and some characteristics of defined contribution plans. More specifically, the cash balance plan promises to pay a specific benefit at retirement (defined benefit) and provides an account balance for each participant based on amounts credited or allocated to the account by the plan sponsor (defined contribution).

In a cash balance plan, an employer contributes a percentage of pay into hypothetical accounts for plan participants and credits interest to those accounts at a rate or index of rates set by the employer. Employees receive periodic statements outlining their accumulated pay and interest credits. However, because the employer promises to pay the account balance, the benefit is defined and insured by the Pension Benefit Guaranty Corporation; the plan is regulated like a traditional defined benefit plan.

Advantages of Cash Balance Plans for Employers and Younger Workers

Cash balance plans provide employers with the funding flexibility of traditional defined benefit plans, along with predictable contribution levels that better enable them to budget for future pension plan costs. Cash balance plans also allow employers to distribute those costs more evenly over covered populations.

Unlike final-average defined benefit pay plans in which benefit accruals grow slowly and accelerate during the later years of an employee’s career, cash balance plans provide a more even distribution of benefits between younger, short-tenured employees and older, long-tenured employees. Therefore, funding expenses are more level over the course of each employee’s career. And, because employers only commit to making regular pay and interest credits to the plan (rather than agreeing to replace a specific percentage of final pay), they are free to set pay and interest credits at levels that reduce costs below those typically associated with traditional defined benefit plans.

Cash balance plans are attractive to younger workers because the benefit is described in terms of an account balance and because it is usually portable (payable as a lump sum) when workers change jobs. Moreover, because a more substantial share of total lifetime benefits accrues earlier under a career average formula than under a final pay formula, younger workers are likely to place a greater value on a cash balance plan than on a traditional defined benefit plan under which most of the benefit is earned in the years just prior to retirement.

In other words, cash balance plans give younger workers more meaningful benefits at an earlier time in their careers, and then continue to spread those benefits evenly over the remainder of their careers. As a result, shorter job tenure and frequent job changes need not mean reduced retirement benefits.

Adverse Effects of Cash Balance Conversions on Long-Tenured Workers

Most of the controversy surrounding cash balance plans is due to the adverse effects of cash balance conversions on the rate of benefit accruals by longer-tenured workers.

Unless specific steps are taken to counteract these effects, the conversion from a final-average pay plan to a career-average plan deprives older, long-tenured workers of the abrupt increase in the value of the benefit they would have realized had their former plan not been discontinued. For employees at or near early retirement age, the value of their old plan benefit may be so much larger than the opening balance in the new cash balance plan that they will accrue no new benefits for a prolonged "wear away" period.

In addition to flattening the benefit accrual curve late in a plan participant’s career, cash balance conversions typically are accompanied by an elimination of the early retirement and other retirement type subsidies commonly associated with traditional defined benefit plans.

As a result of the conversion, workers with many years of service under the sponsoring employer may have their projected benefits reduced at a point in their careers when they have little time left to earn a commensurate benefit from the new plan.

Need for More Timely and Meaningful Disclosures

IEEE-USA strongly believes that pension plan participants must have access to timely and understandable information about benefits provided in employer-sponsored pensions and other retirement savings plans, especially when changes are made to those plans.

Under current law, employers are required to provide a written notice to employees when an amendment to a defined benefit plan is expected to "significantly reduce" the rate of future benefit accruals for any active plan participants. Employers can meet this statutory requirement by sending participants a summary description or a copy of the actual amendment 15 days before the change is to take effect.

However, employers are not currently obligated to describe how the amendment will affect the value of the participants’ benefits or how the future benefit under the new plan compares with the value of the benefit they would have received under their old plan.

Importance of Compensatory Transition Provisions

Absent some kind of transitional relief, the financial impact of a conversion from a final average defined benefit plan to a career average, cash balance plan can be extremely detrimental to long- tenured workers. Older workers, in particular, are likely to experience a loss of the more beneficial defined benefit formula at a time when their advanced age prevents them from earning a comparable benefit under the new plan.

Policy Recommendations

IEEE-USA recommends that employers minimize confusion and reduce or eliminate the potentially adverse effects of cash balance plan conversions on long-tenured workers by:

1. Providing a clear, understandable and timely disclosure of the effects of plan changes on future benefit accruals and employee choices;
2. Permitting long-tenured plan participants the choice between remaining in the old plan or receiving an equivalent pension benefit under the new plan;
3. Offering compensation to long-tenured workers supplemental pay credits, interest credits or more generous opening account balances for financial losses they would otherwise incur under the new plan;
4. Retaining the financial incentives for early retirement and other retirement-type subsidies that are often included in traditional defined benefit plans; and
5. Using conversion savings to improve other employer-sponsored retirement savings or retiree health benefits programs.

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Last Update:  21 Nov. 2000
Staff Contact: Vin O'Neill, v.oneill@ieee.org