Cash balance plans, which might be the last, best hope for the survival of the defined benefit pension plan, have become mired in controversy.
Supporters argue that far more employees, especially younger ones, gain from cash balance plans than lose from them; that cash balance plans cut benefits far less than 401(k) plans; and that cost savings are far less than could be achieved by replacing the defined benefit plans with 401(k) plans.
Critics argue the cash balance plan is simply an unobtrusive way for corporations to cut retirement costs and benefits for older workers, while appearing to improve the pension plan.
But employers insist the goal is to attract young, mobile workers, who stand to get a pittance under old-fashioned pension plans, in which the bulk of a worker's benefits are earned in the last few years before retirement.
In fact, pension consultants said, employees do better under cash balance plans than they would if their employers were to drop defined benefit plans for defined contribution plans.
For one thing, most of the money going into 401(k) plans comes out of workers' own pockets, and even if employers match those contributions, they are simply matches. Employees who don't put any of their own money into 401(k) plans rarely get any freebies from their companies.
Moreover, employees covered by cash balance plans generally are exposed to less of an investment risk than participants in 401(k) plans, who are completely exposed to the whims of the financial markets, experts say.
In addition, cash balance plans have the advantages of 401(k) plans -- individual accounts, even though only on paper and the ability to track the retirement benefit as it grows.
Also, employees who quit their jobs after they are fully vested can walk away with their retirement benefits all at once, although some experts question the wisdom of such a policy, fearing it might prompt workers to squander their savings.
"Traditional pension plans reward people who work for one company their whole life and then retire at the early retirement age," said Richard Shea, a partner at the Washington law firm of Covington & Burling, and a former associate benefits tax counsel in the Treasury Department in the Bush administration. Few workers follow that path, Mr. Shea said.
(Labor Department statistics, however, reveal half of the work force is 38.2 years old -- the highest median age for workers in more than two decades -- and expected to hit 40.6 years in 2006. Half of the workers between 35 and 44 years are staying five years on their jobs, compared with 2.7 years for those in the 25 to 34 age group.)
"Cash balance plans are funded by the employer, not by employee contributions," said Howard C. Weizmann, managing consultant in the Washington office of Watson Wyatt Worldwide.
"When you add in the fact that the Pension Benefit Guaranty Corp. guarantees the benefit, cash balance plans are superior to defined contribution plans," he said.
On the other hand, some consultants who have helped design cash balance plans admit they could be popular with employers that face growing pension liabilities through aging work forces.
Because cash balance plans, by design, usually give all employees similar benefits irrespective of age or tenure, employers frequently can pare their pension expenses through the automatic reductions older employees and those nearing retirement face as a result of the switch. In part that's because employer contributions are based on current pay, not the usually much higher pay employees receive in their last few years before retirement.
Companies also can save money by eliminating subsidized early retirement programs when they switch to cash balance plans. At the same time, companies that sweeten the pot at the time of conversion -- so some employees will leave -- also can use their excess pension assets, instead of corporate cash, to pay severance costs.
And companies drawing down their overfunded pension plans can extend their "contribution holidays" by shrinking their pension liabilities as a result of switching to cash balance pension plans.
This appeals to companies that would rather not shut down their pension plans and pay huge excises taxes to tap excess pension assets.
Safeguarding older workers
Still, numerous companies have put in safeguards to protect their older workers from benefit cutbacks.
A recent study by PwC Kwasha, Teaneck, N.J., of 50 companies that have put in cash balance plans showed one-third gave all employees the choice of staying in the old plan, another one-third extended this choice for some or all employees for a specified period, and enriched benefits for workers during the move to the new plan.
"I don't think the employer community needs to be apologetic about cutting costs, but (it does) need to be upfront about it," said Judy F. Mazo, director of research in the Washington office of The Segal Co., who is heading up a Labor Department-sponsored task force studying cash balance pension plans.
"One of the motivations to move to cash balance plans is they do provide cost savings," said economist Sylvester J. Schieber, director of research at Watson Wyatt & Co., Bethesda, Md.
Employers and consultants professing that costs are not a consideration "are either being naive or disingenuous," because global competition forces companies to be sensitive to costs, he said.
Little wonder then that these plans first proliferated in industries such as financial services, telecommunications and utilities, facing increased competition as a result of deregulation. They also became popular some years ago in the oil industry, facing declining gasoline prices and pressure to reduce costs.
But some companies counting on lowering their pension costs as a result of moving to cash balance plans might be in for a surprise.
Companies with high turnover of employees may in fact face higher costs and drops in funding levels if those workers stay just long enough to become vested and then walk out with lump sums representing the equivalent of their earned benefits.
In other words, companies offering lump sums -- practically all with cash balance plans -- might need to revisit their investment policies and asset allocations, including hiking their equity exposure to boost returns, said Michael Peskin, principal of the global pensions group of Morgan Stanley Dean Witter & Co., New York.
Companies also could forgo the opportunity of earning higher returns on their pension assets if they have to tap them to pay lump sums to departing employees, he said.
In contrast, because workers with short tenure earn little in traditional defined benefit plans, companies face far smaller payouts for employees who quit after a few years if they allow lump sums. Federal pension laws also permit companies to cash out employees whose earned benefits total less than $5,000.