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Behind cash-balance pensions
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July 1, 1999: 10:49 a.m. ET
A bust for older employees, young workers may benefit from controversial plans
By Staff Writer Nicole Jacoby
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NEW YORK (CNNfn) - Dreamy visions of retirement occupy the minds of many a worker: the summer house on the cape, a brand new car and oodles and oodles of free time.
Unfortunately, a new trend in pension plans has left many prospective retirees anything but relaxed.
As an increasing number of big corporations replace traditional pensions with cash-balance accounts, many older workers have voiced concerns that the new plans diminish long-promised benefits, forcing them to work longer and later in life for the same perks.
At the same time, companies claim they are responding to the needs of a younger, more mobile work force.
Cash-balance accounts: a primer
Cash-balance pensions differ primarily from their traditional counterparts in that they are based on an employee's career-average -- rather than final -- salary.
Under the cash-balance plan, younger employees see higher benefits at an earlier age, but the benefits level off over their working years. In contrast, workers with traditional plans accrue benefits based on total years of employment with the company, as well as average pay in final years of service. Under traditional plans, a very large share of a person's pension tends to be earned in the last five years of employment.
Companies with cash-balance plans open hypothetical accounts in an employee's name, crediting that account based on a percentage of an employee's pay. A specified interest rate, commonly the Treasury rate, is applied to those accounts. Upon leaving the company, employees can take the balance of the account with them, either as a lump sum or as a stream of payments.
Although considered a hybrid of defined benefit and contribution plans, cash-balance accounts are legally subject to the same rules that regulate traditional pensions, in which the company takes on the investment risk (as opposed to 401(k) benefits and the like.)
Behind the trend
Cash-balance plans were first approved by the Internal Revenue Service in 1985 and since then a growing number of companies have embraced these hybrid pension plans.
Bank of America (BAC) was the first to introduce the plan, with industry heavyweights including AT&T (T), IBM (IBM) and Bell Atlantic (BEL) among the hundreds of companies that eventually followed suit.
Employers have welcomed these plans for a variety of reasons. For one, they tend to be more cost-effective, reducing the administrative expenses associated with calculating and doling out traditional pensions. Total benefits paid out may also be reduced under some cash-balance formulas.
But the shift to cash-balance pensions has been driven by more than economics.
"Times have changed," AT&T spokesman Burke Stinson said. "The idea of working for the same company until you're 65 is quaint, but not common."
The telecommunications giant first introduced cash-balance pensions to managers in 1996 as part of an effort to downsize. Since then, the company has expanded the plan to all its employees, recognizing the growing importance workers place on mobility.
The desire for portability has made cash-balance plans particularly attractive to companies hoping to draw younger workers. In high-turnover industries, such as technology, cash-balance pension plans can be a "good recruiting tool," said the Carol Quick, research analyst for the Employment Benefit Research Institute.
Companies realize that "these employees may eventually change jobs, but they still want to attract them in the short term," she said.
Boon for the young?
Indeed, while many older workers may feel snubbed by the shift to cash-balance pensions, younger workers could see substantive advantages in the controversial plans.
A 1998 study by the Society of Actuaries, which addressed the pros and cons of each plan over the course of an individual's career, found that two-thirds of participants received higher benefits under the cash-balance plan. The study compared a hypothetical cash-balance plan to a hypothetical traditional plan and did not take into account conversion.
For those who plan to change employers throughout their careers or leave the work force for periods of time, cash-balance pensions are clearly preferable, the study concluded.
These plans enable such workers "to build up a retirement benefit that is greater than if they were only covered under a traditional plan," Quick said.
Women are particularly likely to benefit from cash-balance plans, since they are more likely to leave the work force temporarily, making the accrual of benefits under traditional plans difficult.
Bust for career workers?
What has unnerved so many older workers is the fear that the new plans will diminish long-promised pensions.
While the law forbids companies from reducing an worker's previously-earned retirement benefits, companies are legally permitted to change an employee's future benefit accrual.
However, the problem lies not in the cash-balance plans themselves, but in the conversion process, says David Certner, senior coordinator for economic issues at the American Association of Retired Persons.
The shift from traditional to cash-balance plans can leave long-term employees with fewer benefits than previously banked on, depending on how a given company handles the switch.
AT&T's Stinson admits some older workers may feel slighted by the company's new cash-balance plan.
"The veterans seem to feel they are not getting as much under the cash-balance plan... and in some cases, that's probably true," Stinson said. But many employees discount the gains realized from their regular salaries, stock options and bonuses, he adds.
While some companies do nothing to compensate for the transition, others grandfather older workers or give them a choice between the new and old pensions. Though that initiative does no harm to many older staff members, it is little consolation for those workers just below the cut-off age.
"The disadvantage for (some) older workers is that they are in the worst part of both plans," Certner said. Many long-term employees are deprived of the traditional plan just as they are about to see long-awaited gains. Cash-balance accounts reward accumulation, so older worker just starting the plan have less time than younger counterparts to amass retirement benefits.
Some companies, such as IBM (IBM), have tried to compensate for the switch by contributing a higher percentage to the cash-balance accounts of longer-term employees.
Whether such measures make up for the losses suffered as a result of a conversion depends largely on how individual plan sponsors set up the provisions, says Quick.
"You can't generalize about conversions," Quick said. "It very much depends on the formula for the cash-balance plan… each situation is unique."
Additional considerations
Age discrimination can also come into play. While companies cannot legally roll back previously-earned benefits, they may stop adding contributions to older employees' pension funds. Consequently, in some situations, older employees may have to work more years to receive the same benefits they would have under a traditional plan.
Lawsuits regarding the issue have already been filed and legislation aimed at curbing this practice is expected to be introduced by Iowa Senator Tom Harkin in the coming months. The Democrat's proposal would require companies that change their pension plans to maintain benefit contributions for their older employees.
Disclosure is another potential stumbling block, says Certner.
Many employees feel they lack the information to judge how cash-balance conversions will affect their benefits at retirement. Workers often miss "reductions" because complicated calculations are required to determine one's future benefit accrual in either plan.
"Employees already aren't clear on what they are getting (in terms of pension benefits.) Under the new plan, it is even less clear," Certner said.
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