WASHINGTON - Older workers are the hardest hit when employers convert their traditional pension plans into cash balance plans. But younger workers who, in theory, stand to benefit from such conversions don't do much better, because few employers vest employees earlier than five years, and young workers seldom stay on a job that long.
Those are the hard-hitting conclusions of the General Accounting Office, the investigative arm of Congress, in two reports on cash balance plans released Sept. 29.
The studies also said employers converting their plans seldom spell out the full impact of these changes, adding to the confusion of workers at companies that have switched to cash balance plans.
The reports had been requested by Sen. Charles E. Grassley, R-Iowa, chairman of the Senate Special Committee on Aging, and three Democrats in the House - Robert E. Andrews of New Jersey, and Major R. Owens of New York, both members of the House Education and the Workforce Committee, and William J. Coyne, of Pennsylvania, a member of the House Ways and Means Committee.
The reports come out even as the Senate is deliberating on a pension package that could cement the standing of cash balance plans. The package also would make it harder for participants to sue employers for age discrimination.
"Unlike traditional defined benefit plans, cash balance plans can result in a declining rate of normal retirement benefit accrual over time. The declining accrual rate can result in older workers receiving lower benefits at retirement from a cash balance plan than they would have from a traditional final average pay plan if it had not been converted," the GAO report on the implications of conversions to cash balance plans states. The other report is on implications for retirement income.
In traditional pension plans, workers earn the bulk of their benefits at the end of their careers. Because of this, workers who quit their jobs before they reach retirement age often earn only a small pension benefit. And most workers must wait until they are 65 to collect their pension checks from their former employers.
But, in cash balance plans, the benefits workers earn are spread out evenly over their careers. And, the plans are more portable than traditional DB plans. But, workers in their 40s and 50s lose out because they have fewer working years left to build up their account balances.
Workers who tend to do better under cash balance plans are those who stay at a company for at least 10 years - a 30-year-old who quits a job after 10 years would collect a lump sum about one-and-a-half times that from a traditional pension plan, the GAO found.
The GAO also acknowledges that job hoppers are more likely to receive higher total retirement income if they switch to employers with cash balance plans than to those with traditional pension plans.
Moreover, older workers also tend to be hurt more by "wearaways," or periods during which they do not earn any new benefits, when their companies switch to cash balance plans, the GAO states. Most of the firms the GAO surveyed provide some sweeteners to workers to soften the blow of the changes, but the extent of the sweeteners varies.
As a result, the GAO recommends that lawmakers adopt changes in the federal pension law and the tax code banning companies from creating such pension plateaus when they switch to cash balance plans.
But the agency did not stipulate if that ban should extend to wearaways of subsidized early retirement benefits, through which most older workers tend to suffer the biggest losses of their pension benefits. A provision in the big pension package has come under fire from participants' groups because it is silent on the issue of subsidized early retirement benefits.
What's more, almost half of the Fortune 1,000 companies with cash balance plans that the GAO surveyed did not tell workers that their accounts are theoretical only, according to the GAO report on the implications of cash balance plans for retirement income.
"None of the documents Fortune 1,000 companies with cash balance plans provided to plan participants that we reviewed provided an explanation of the difference between the accrued benefit and the hypothetical account balance. Participants would need such information to assess accurately the impact of career decisions on their pension benefits," the GAO report states.
The agency found about 19% of the nation's largest companies had cash balance plans. Because of the vagaries of interest rates, participants in cash balance plans may sometimes collect more than what they have built up in their paper accounts, but pension law forbids them from ever receiving less than what is in their accounts.
But the GAO's recommendation that lawmakers amend federal pension law to require employers to give workers better information about changes made to pension plans is nothing new. In fact, a provision in the pension package being considered in the Senate would require employers to give workers an "estimation tool kit" that would include software or calculation instructions. Such tools would let participants figure out their benefits under the traditional pension plan and the cash balance plan.
Under current law, employers must simply give workers a notice, at least 15 days before the changes become effective, that they could see a cutback in future benefits. The law does not require employers to say anything about the possible loss of early retirement benefits.
The GAO specifically recommended that the Labor Department ensure employers clearly tell their workers that the individual accounts provided under cash balance pension plans are on paper only, and very different from those employees own under 401(k) plans.
The GAO also recommended that the IRS should stop approving new cash balance pension plans until it issues regulations spelling out that these plans are, in fact, distinct from traditional defined benefit pension plans or defined contribution plans. Because of the controversy surrounding these plans, the IRS already has informally stopped approving conversions since last October. The IRS, however, has not stopped giving the green light to new plans.
The GAO also proposed that regulators define the accrued benefit provided by cash balance plans under the new framework it lays out for hybrid plans. Employers and pension consultants suggest (and the pension package passed by the Senate Finance committee in early September proposes) that this be defined as the account balance participants accrue in their paper accounts. Critics of cash balance plans say that since such plans are technically defined benefit plans, rules for such plans should apply and the accrued benefit should be defined as an annuity at age 65.
Not surprising, even before the reports were officially released, proponents and critics of cash balance pension plans had begun using the GAO reports to buttress their points of view.
Praise on 2 sides
Those representing participants noted that the reports are critical of cash balance pension plans; employer groups found cause to celebrate that the reports emphasized the need for prompt regulatory action to develop new rules.
"I applaud the GAO for calling on the IRS to suspend cash balance pension plans until there are more comprehensive worker protections in place," said Sen. Tom Harkin, D-Iowa, who is a vocal critic of cash balance plans and had introduced legislation on these plans last year.
But Mr. Grassley is not happy. In fact, Mr. Grassley, in two scathing letters to David Walker, the head of the GAO, criticized the analysis of the investigative agency as faulty. The agency, in its analysis of accrual rates, used a mathematical model that assumed the affected worker spent his entire career at one job.
Charles A. Jeszeck, a GAO analyst who worked on the reports, said the analysis for the rate of accrual was based on work done outside that mathematical model. "Within the model, all that we concentrate on are the issues of conversion, and what is important is just the age at conversion," he explained.
The reports' findings on disclosures also have come under criticism from some employer groups as being based on summary plan documents alone, which are perfunctory documents, and not taking into account the detailed communication packages many employers have given workers about the changes.
Mark Ugoretz, president of the ERISA Industry Committee, a Washington-based employer group, said he was "not displeased" with the report because it vindicates employers, who have been asking regulators for specific guidance on cash balance plans for years. Mr. Ugoretz hopes the reports will prod the agencies into issuing rules.
Meanwhile, the GAO also was expected to release Oct. 2 a report on the top-heavy rules that ensure small business owners do not give themselves disproportionately rich benefits compared with rank-and-file workers. Critics say the rules are a reason many small businesses do not offer pensions to their workers.
The GAO report supports the existence of the rules, while many lawmakers including Mr. Grassley support a loosening of the rules. In fact, H.R. 1102, the pension bill before the Senate, includes a provision that would water down the rules. The Senate was expected to have taken action on the bill before the report would have become public, making the report's findings moot.
Mr. Grassley, who had ordered the top-heavy report more than a year ago, did not release it for more than a month because he was unhappy with the findings. The report's "all vs. nothing" approach is not helpful in considering proposals on the rules, he wrote to Mr. Walker.