WASHINGTON - The Treasury Department has given its stamp of approval to cash balance plans.
More than three years after it began reviewing the hybrid pension plans, the Treasury Department proposed regulations that state unequivocally cash balance plans do not discriminate against older workers.
Once the proposal is finalized, the department intends to lift the moratorium on determination letters for conversions of traditional plans to cash balance plans, imposed in 1999. First, though, the proposal is subject to 90 days of public comment, followed by a hearing.
The guidance clears the way for hundreds of large companies sitting on the sidelines to switch their defined benefit plans to cash balance plans. It also could encourage small employers without pension plans to set up the hybrid plans.
"This means that corporate America is going to go back to the practice of converting defined benefit plans to cash balance plans because there is no cloud hanging over them," said Hugh Forcier, partner in the Minneapolis law firm of Faegre & Benson LLP, and a big proponent of cash balance plans.
Representatives of employer groups agree.
`A big deal'
"This is probably the most significant development to revitalizing defined benefit plans since ERISA," said Brian H. Graff, executive director of the Arlington, Va.-based American Society of Pension Actuaries. "This is a big deal. ... I am predicting that companies without defined benefit plans will seriously start considering them."
James M. Delaplane Jr. is a partner in the Washington office of Davis & Harman, which represents the American Benefits Council, a Washington group of the nation's largest employers. He said the proposed new regulations would permit employers to continue offering defined benefit plans.
"In today's environment, there's a real recognition of the advantage of defined benefit plans. These cash balance plan vehicles are the place where there has been any energy and vitality in the DB spectrum, and moving toward the resolution of some of these issues will allow that vitality to continue."
The Treasury Department's guidance also permits employers to incorporate "wearaways," or pension plateaus, for some employees when they convert to cash balance plans. In cash balance plans, employees get their benefits through faux individual accounts, which are credited annually with a percentage of pay. Wearaways occur when employers freeze the traditional pension plan and set up the new accounts with opening balances that are less than the value of the benefit employees had earned under the frozen plan.
New requirement
The new guidance requires employers to ensure the opening account balance in cash balance plans is equal to at least the present value of the benefits earned under the old plan, calculated using interest rate assumptions that are "reasonable and age neutral."
Companies that converted to cash balance plans years ago but did not set them up that way won't have to worry so long as the interest rates they used in the calculation were reasonable, Treasury officials said.
While the proposal doesn't define reasonable, the Internal Revenue Service is expected to go after employers that use inordinately high interest rates - which would result in very small account balances when the value of the accrued benefit is discounted back to the present. (A July 2000 study by UNIFI Network, now part of Mellon Financial Corp., found that 70 out of the 100 surveyed pension plans set the opening balance upon conversion to the present value of the accrued benefit, while 13 set the opening balance to be more than the previously earned benefit.)
Not surprisingly, groups representing participants who lost benefits when their employers switched to cash balance plans say they will continue to fight the hybrids, although they expect little assistance from the Republican-controlled Congress.
Mark Iwry, treasury benefits tax counsel in the Clinton administration, said the proposal reflects the Treasury Department's decision not to impose additional requirements on employers to protect older workers in cash balance conversions by letting them stay in the traditional plan, giving them a choice between the two plans, or providing higher pay credits.
Harkin's vow
Sen. Tom Harkin, D-Iowa, whose bill banning wearaways failed to pass the Senate by just two votes in July 2000, isn't giving up the fight. "I will continue to look for appropriate venues to offer the amendment I offered in 1999 to end this practice," he told Pensions & Investments.
"I agree with the Treasury Department that cash balance plans aren't inherently discriminatory," he said. "Obviously in the world of cash balance plans there are Cadillacs and there are Yugos. However, older Americans are clearly hurt by the Treasury's view that wearaway is not age discrimination. After all, when a wearaway occurs, younger workers are receiving greater pay for the same work by way of money put into the pension plan."
Conversions to cash balance plans have been controversial because they frequently tend to hurt midcareer and older workers. That's because employees in traditional pension plans build up the bulk of their benefits in the years approaching retirement, whereas participants in cash balance plans, as in 401(k) plans, earn the same benefits over the span of their career.
There's also debate over whether regulators should treat cash balance plans for age discrimination purposes as 401(k) plans - in which all workers get the same percentage of pay, regardless of age - or as defined benefit plans, which by law are expressly forbidden from reducing an employee's rate of benefit accrual with increasing age.
The Treasury Department's proposed rules state regulators would regard them as no different from the run-of-the-mill 401(k) plans.
"It is the same rules that defined contribution plans have to satisfy, because they accumulate the same way as defined contribution plans," said Bill Sweetnam, benefits tax counsel at the Treasury Department.