Honesty really is the best policy. Unfortunately, some companies and their benefits consultants didn't believe that, and as a result, the image of cash balance plans has been tarnished, perhaps permanently. The lack of candor might even lead to legislation that could harm cash balance plans, and, ultimately, employees.
The problem is, employers and their consultants tried to hide the fact that, in a switch from a plain defined benefit plan to a cash balance plan, some older workers often will have lower retirement benefits than they would have had if the defined benefit plans had continued unchanged.
A cash balance plan is a defined benefit plan onto which an account balance, based on each employee's accrued benefit, has been grafted so that at any point an employee can see the value of his or her retirement benefits, just as with a 401(k) plan. Also like a 401(k) plan, a participant can take the account balance as a lump sum when he or she leaves the company. This is not always possible with defined benefit plans.
Some longer-term employees lose out in the switch because in a cash balance plan, the benefit accruals are more level than in a traditional defined benefit plan, in which benefit accruals accelerate as an employee approaches retirement. As a result of this more level accrual of benefits, younger employees and older, longer-term employees are treated more equally.
The benefit accrual has to be more level; otherwise, the account balances of younger, shorter-tenured employees would be too small for too many years to be of any interest to younger employees, and the cash balance plan would be no competition for the 401(k) plan. The cash balance plan also addresses an inequity in the traditional defined benefit plan not usually recognized -- that younger employees who leave a company after only a few years are actually subsidizing the retirement benefits of older employees. This is not so with a cash balance plan.
Thus, employers have been caught between a rock and a hard place in trying to satisfy two constituencies -- the younger, scarcer employees of the post-baby boom generation who want 401(k)-type plans, and older, more numerous baby-boom generation employees who want certainty of benefits, and who have been counting on the final-pay defined benefit plan.
Younger employees prefer 401(k) plans because they can see their accounts growing year-by-year and they have control over the assets. If they leave their companies, they can take the assets with them, rolling them into an IRA. Older employees often prefer the traditional defined benefit plan, which generally rewards long service by providing increasing levels of retirement benefits as age and years of service increase.
The cash balance plan is a compromise. And there is a price to pay for the transition. Companies often protect employees close to retirement from that price, but because of the more level accrual of benefits, some of those between 50 and 60 often find their retirement benefits under a cash balance plan will be far less than they had counted on under the old defined benefit plan.
Companies have generally not been honest with these employees, at best providing "disclosure" forms about the change that require an actuary to decipher. This must change. Employers must be forthright about the effects of the changes. After all, they have a right to change benefit formulas for future service at any time. They are breaking no laws by switching to cash balance plans.
Employers must trust employees with the truth about the changes. Yes, some will have lower pensions than they expected, but a far greater number will benefit from the change. And the company needs to make this change to attract and keep the younger employees it needs to continue growing.
Employers should note employees will generally be better off than if the company had dropped the defined benefit plan and replaced it with a 401(k) plan -- where the employees have to contribute from their own paychecks before the company contributes -- or if the company had simply terminated the defined benefit plan.
Cash balance pension plans are a valuable hybrid. They are an attempt to fix a weakness in defined benefit plans -- the lack of appeal to younger employees -- and the weaknesses of 401(k) plans -- the contribution requirement and the investment risk imposed on employees. They have been unfairly tarnished by the negative publicity generated by the lack of candor of consultants and employers. Both must be more honest in the future.
