Compensation and Working Conditions Summer 2000 3

Cash Balance Pension Plans

KENNETH R. ELLIOTT

JAMES H. MOORE, JR.

Cash Balance Pension

Plans: The New Wave

A number of larger employers have recently restructured

their defined benefit pension plan offerings by switching

from a typical pension plan based on terminal earnings

formulas to a cash balance plan based on average career

earnings. Many questions as to who benefits from such

transitions, as well as to how such transitions should be

governed, remain unanswered.

Kenneth R. Elliott is an economist in the Office

of Compensation and Working Conditions, Division of Compensation Data Analysis and Planning, Bureau of Labor Statistics; James H. Moore,

Jr. is an economist in the Office of Research,

Evaluation, and Statistics, Division of Policy

Evaluation, Social Security Administration.

Telephone: Kenneth R. Elliott (202) 691-5164

 James H. Moore, Jr. (202) 358-6232

E-mail: Elliott_K@bls.gov

 James.H.Moore@ssa.gov

Historically, defined benefit

pension plans have been vehicles geared towards rewarding longevity. The individuals building sizable “nest eggs” in a defined

benefit pension plan were those working for the same employer for their

entire career.

For many years, such defined benefit pension plans have been widely

used by employers to provide retirement income to employees. However,

since 1985, the number of defined benefit pension plans insured by the Pension Benefit Guaranty Corporation1

(PBGC) has dropped from 112,000 to

42,000. Conversely, the total number

of participants in these plans has recorded modest growth. Between 1980

and 1996, participation increased from

27.6 million participants to 33 million.2 However, like the total number

of defined benefit plans, “active participation” declined 4.1 million between 1988 and 1996, dropping from

22.2 million to 18.1 million.3 (See

glossary of terms, p. 6.)

More recently, employee participation in defined contribution retirement

plans has been on the rise. In addition to giving employees more autonomy in building their retirement

benefits, defined contribution retirement plans provide employees with

increased flexibility in determining

how their retirement contributions will

be invested, but at the cost of incurring more risk. In addition, defined

contribution retirement plans typically

provide a benefit that employees can

take with them should they change

jobs, a feature that is not traditionally

found in defined benefit pension plans.

Is it possible that there exists an intersection between these two distinct

types of retirement plans? The intersection might be the “cash balance”

pension plan.

Cash balance versus defined

benefit

A cash balance plan, a type of defined

benefit pension plan, promises an employee an employer contribution equal

to a percent of each year’s earnings

and a rate of return on that contribution. The benefit is always expressed

as a total account balance. This is in

contrast to a traditional defined benefit plan, which typically promises an

employee a flat dollar amount based

on years of service or an annuity—a

periodic benefit usually based on years

of service and an employee’s earnings

in the years closest to retirement.

Cash balance plans build value

steadily and often at the same pace for

all employees—whether they’ve
4 Compensation and Working Conditions Summer 2000

worked for the employer for 1 or 30

years. The focus of these plans is on

wealth building and “portability.” On

the other hand, traditional defined

benefit plans are designed to encourage career employment with one employer. Instead of focusing on wealth,

they focus on providing retirement security; the design of these plans does

not reward employees who choose to

change jobs.

Cash balance plans provide more

uniform benefit accrual throughout the

employee’s career. Conversely, under

a traditional defined benefit plan, the

value of a dollar of promised future

retirement income is directly related

to the discounting period. In addition,

most defined benefit plans are based

on a multiple of an employee’s years

of service and final pay with the employer. Thus, an increase in compensation in one year increases the value

not only of that particular year’s benefit accrual, but also of the benefit accruals for all prior years.

It is important to note that, for cash

balance plans, there is not actually a

cash account in existence for each participant. Hypothetical retirement accounts define an employee’s accrued

benefit at any point in time. The account is merely a record-keeping feature. Cash balance plans are funded

on an actuarial basis, in the same manner that traditional defined benefit

plans are funded. The amount the

employer contributes to the plan each

year is based on actuarial assumptions.

In addition, employers can invest the

cash balance plan funds just like they

can invest other defined benefit plan

funds. Participants’ retirement accounts grow by earning annual credits that typically are based on a flat

percentage of pay and may or may not

be integrated with Social Security benefits. In addition, accounts earn an

interest credit each year that is tied to

some external index, such as the Consumer Price Index or the rate on U.S.

Treasury bills. For example: employer

XYZ provides a cash balance plan that

credits all employees’ accounts with 6

percent of their annual salary. In addition, these accounts are credited with

5 percent interest, which is paid by the

employer on an annual basis. This

method of benefit accrual allows cash

balance benefits to grow more evenly

over an employee’s career than would

occur under a final average pay plan—

in which the majority of benefit accrual takes place in the final few years

prior to retirement. In other words,

benefits for cash balance plans are determined by an employee’s pay averaged over his or her total years of service. Benefit accrual formulas based

on an employee’s career average earnings tend to be more beneficial to employees just beginning their careers

than to employees who are close to

retirement and have worked most of

their career under a more traditional

defined benefit plan.

Cash balance versus defined

contribution

Although cash balance plans may appear similar to 401(k) plans, there are

numerous differences between them;

some are critical from a policy perspective. First, in cash balance plans, the

investment decisions and the investment risks associated with those decisions generally are the responsibility

of the employer, not the employee.

Even though the benefits are expressed

in the form of individual accounts,

assets are managed in the aggregate

by the plan trustee. Second, cash balance plans, unlike 401(k) plans, are

covered by the PBGC’s insurance program, meaning participants’ benefits

are protected even if the plan or the

company runs into financial difficulty.

Finally, cash balance plans must offer

employees the ability, within the plan,

to convert their account balances to

lifetime annuities at no additional cost.

Are cash balance plans gaining

in popularity?

As mentioned, traditional defined benefit pension plans typically base the accrued benefit on a multiple of an

employee’s salary level and years of

service. These plans are backloaded—meaning much of the value

of the benefit is earned in the final

years just prior to retirement—and, as

such, are ideal for employees who

spend their entire career with a single

employer. The assumption that employees experience their highest earnings toward the end of their careers

implies that the pension benefit due

to them would accrue much faster at a

later stage of their employment. If

workers leave the firm before qualifying for retirement, they suffer a pension “capital loss” by giving up the

opportunity for a substantial graduated

increase in pension benefits.4 Thus,

the benefit in remaining with the same

employer for a number of years is established.

Plans based on final earnings can

produce little benefits for employees

who switch jobs several times during

their careers. The back-loading of

traditional defined benefit plans

makes it costly for employees to leave,

thereby reducing the likelihood of

mobility.5 On the other hand, cash

balance plans may be more responsive

to a mobile workforce and may be

more attractive to employees prone to

change jobs throughout their careers.6

For mobile workers, cash balance

plans may provide meaningful benefits sooner and more evenly over a

career, so that shorter job tenure need

not mean reduced retirement benefits.

The design of cash balance plans responds to workers who want to transfer accumulated pension benefits

when changing jobs. This portability

provision affords workers who switch

jobs the opportunity to leave their assets in the plan (where they will continue to receive interest credits), elect

an annuity, or roll over their account

balance to their next employer’s retirement plan or into an IRA. Portability provisions are rarely offered in

traditional defined benefit pensions—

fewer than 1 in 10 covered workers

had such a feature in 1997.7

Although cash balance pensions

have been in existence for a number

of years, they have recently begun to

receive much attention as new plans

are surfacing and, in some cases, replacing traditional defined benefit

plans. Data from the BLS Employee

Benefits Survey (EBS) indicate that
 Compensation and Working Conditions Summer 2000 5

Cash Balance Pension Plans

Traditional defined benefit, 68 percent

CHART 1. Percent distribution of pension plans among Fortune 100 companies, 1998

Cash balance,

16 percent

Pension equity,

6 percent

Defined contribution,

10 percent

SOURCE: Watson Wyatt Comparison 1998

participation in cash balance pension

plans among employees in medium

and large private establishments

doubled between 1995 and 1997, from

3 to 6 percent of all defined benefit

plan participants.8 These data are supported by the fact that, overall, cash

balance plans have increased from 5

percent to 12 percent in just the last 2

years, according to a survey conducted

by Hewitt Associates. Furthermore, in

1998, 16 percent of Fortune 100 companies offered their employees a cash

balance plan. (See chart 1.)9

Traditional defined benefit plan

formulas are often complex and are not

expressed in the form of an account

balance. Cash balance plans—with

their account balance and understandable benefit accrual—seem to provide

benefits that are easier for employees

to comprehend. Employers are under

the impression that very few employees understand, or even appreciate,

traditional defined benefit plans because of the difficulty in determining

the benefit to which they are entitled:

 ...[It] is perceived that some

employees have little understanding of or appreciation for

traditional pension plans....

Plan participants tend to appreciate cash balance plans because

they can actually see their pension ‘benefit’ accruing throughout their years of service with

an employer, and because they

can take that accrued benefit

with them when they leave, even

if that is years in advance of retirement age. 10

According to data from the 1998

Current Population Survey, the median

number of years workers were with

their current employer was 3.6, 1.4

years less than the 5-year vesting requirement of most defined benefit

plans.11 (This measure of tenure fluctuated between 1983 and 1998, decreasing from 3.8 to 3.6 years.)12 Vesting requirements in cash balance plans

are similar (5 years for cliff vesting

and 7 years for graduated vesting—

see glossary of terms). Therefore, cash

balance plans may be more attractive

to younger workers (workers more

likely to change employers) because,

once vested, they are guaranteed an

unreduced benefit if they change employers. On the other hand, workers

closer to retirement may be disenchanted with the cash balance plan

because they tend to receive smaller

payouts at retirement by converting to

this type of plan than they would have

if they had remained with their more

traditional defined benefit plan. The

payout received under the cash balance plan would probably be smaller

because the benefit would be calculated using a career average of earnings as opposed to an average of earnings over the worker’s final few years

of employment. The career average

method tends to bring employees’

overall average down because it accounts for lower earnings levels early

in their careers.

Why do cash balance plans appeal to employers?

Conversion from a traditional defined

benefit plan to a cash balance plan may

be the result of: (1) a comprehensive

redesign of an employer’s compensation package as a means for easily ascertaining future liability; (2) a need

to attract and retain workers in a mobile environment; and (3) a desire to

avoid the complexities involved in

explaining traditional defined benefit

plan annuity benefits and their oftencomplex formulas.

Conversion to a cash balance plan

may be accompanied by improvements to other benefit plans. When

some employers institute a conversion,

they increase their nonelective or

matching contributions to their current employees’ 401(k) plans to offset any reduction in benefits that

would occur otherwise.

A recent study by Watson Wyatt

Worldwide, a benefits consulting firm,

suggests that “employers with cash

balance plans...are more likely than

employers with traditional defined

benefit plans to make both non-elective (12 and 10.8 percent, respectively)

and matching (88.9 and 77.5 percent)

contributions to employee 401(k)

plans.”13 Watson Wyatt also has completed another study indicating that

“45 percent of employers realized

some cost savings, while 37 percent

saw costs increase, and 18 percent experienced a minimal effect on costs.”14

From another perspective, according to a recent Society of Actuaries

study, if costs were held constant,

about two-thirds of employees would
6 Compensation and Working Conditions Summer 2000

do better under cash balance plans

than under traditional defined benefit

plans. Additionally, the study suggested that women—who have a tendency to have slightly shorter job tenure—do better under cash balance

plans than they do under traditional

defined benefit plans.15

Employers find that the cash balance plan provides additional funding

flexibility, thereby easing the burden

of budgeting for future pension plan

costs. The cash balance plan does not

define the employer’s contributions,

but instead defines the future pension

benefits that will accrue in each individual account. The employer’s contributions are based on actuarial valuations, as is the case with traditional

defined benefit plans. These actuarial

valuations describe an amount that

must be present in the plan to fund all

employees’ pension benefits. The

employer contributions to the plan in

any given year may be more or less

than the sum of the additions to all

participants’ accounts. The employer

or plan sponsor, or both, determine

how the assets from the plan will be

invested and assume all risks. Investment gains and losses affect the

employer’s future contributions. If the

fund earns a rate of return equal to or

greater than the rate of return promised to employees, the plan can become

fully funded without additional employer contributions.

There are other reasons why cash

balance plans may appeal to employers. As with traditional defined benefit plans, employers still bear the risk

and receive the reward from plan investment strategy. But cash balance

plans may not subject employers to the

same degree of risk of preretirement

inflation that can occur with terminal

earnings formulas.16 Benefits are expressed in terms of a lump-sum payment, and at any point in time the

employer knows the value of an

individual’s account. Large wage increases just prior to retirement must

be funded, but they do not have the

same influence on employees’ final

benefits that they would in traditional

defined benefit plans.

GLOSSARY OF TERMS

Active participation refers to plan participants who are actively employed and

still accruing plan benefits.

Annuity is an investment on which one receives fixed payments for a lifetime or

for a specific number of years.

Career earnings formulas are based on a percentage of average career earnings

for every year of service recognized by the plan.

Cash balance pension plans are defined benefit pension plans in which each

participant has a hypothetical account that is credited with a dollar amount. The

account earns interest based on an employer contribution usually calculated as a

percentage of pay.

Defined benefit pension plans provide employees with guaranteed retirement

benefits based on predetermined benefit formulas. A participant’s retirement age,

length of service, and preretirement earnings also may affect the benefits received.

Defined contribution retirement plans specify the level of employer contributions and require those contributions to be placed in individual employee accounts.

Discounting period is the length of time used to calculate the present value of

dollars (annuity) due in the future.

Dollar amount formulas are used to calculate benefits based on a flat dollar amount

for each year of service recognized by the plan.

Early retirement age is the age or combination of age and service at which an

individual can retire and receive full benefits less a reduction for each year of

retirement prior to reaching normal retirement age.

Nonelective contributions are employer contributions (other than matching funds)

that an employee may not elect to have paid in cash in lieu of being contributed to

their retirement account. They are nonforfeitable and ineligible for withdrawal

prior to the attainment of certain conditions.

Normal retirement age is the age at which an individual can retire and receive

full accrued benefits.

Pension equity plans credit employees with a certain number of points for each

year of service. When the participant terminates employment or retires, the benefit is determined by multiplying the participant’s average level of pay over his or

her career by the total number of points earned. The benefit is expressed as an

account balance, much like the benefit of a cash balance defined benefit plan.

Portability allows participants to transfer accumulated pension benefits when changing jobs.

Terminal earnings formulas are based on a percentage of average earnings during a specified number of years at the end of a worker’s career (or when earnings

are their highest), multiplied by the number of years of service recognized by the

plan.

Vesting refers to the number of years an individual must work for a particular

employer before earning a nonforfeitable retirement benefit.

Cliff vesting is a form of vesting in which vesting occurs after an employee

satisfies the service requirements for 100-percent vesting, for example, after 5

years. There also may be an age requirement combined with the service requirement.

Graduated vesting is a form of vesting in which vesting occurs gradually over a

predetermined period until the employee is fully vested (100 percent).

Wearaway occurs when, as a result of a plan conversion, participants’ previously

earned benefits do not accrue additional value until the new plan value equals the

old plan value.
 Compensation and Working Conditions Summer 2000 7

Cash Balance Pension Plans

25 30 35 40 45 50 55 60 65

Employee's age

Transition issues

When a company converts to a cash

balance plan, all employees are legally

entitled to the benefit they accrued in

the prior plan as of the conversion date.

Among the biggest issues that arise in

the transition from a traditional defined benefit plan to a cash balance

plan is that younger employees will

typically fare better than they would

have under the original plan because

the accrual pattern under a cash balance plan will provide them with a

larger benefit if they leave their current employer. Workers with more

years of service and a traditional defined benefit plan may not do as well.

Chart 2 shows how cash balance plan

benefits accrue in relationship to traditional defined benefit plan benefits.17

The extent of any difference in benefits will depend on the design of the

old and new plans and the nature of

the transition provisions that may accompany the conversion. Employers

may offer an array of transition arrangements. One of the arrangements

could be the imposition of a “grandfather clause,” whereby some or even all

employees may remain in the prior

pension plan either until retirement or

for a period of years. Other arrangements may include providing some, or

all, workers with additional amounts

in their opening cash balance plan

accounts, or providing additional pay

or interest credits to employee accounts

for a predetermined number of years

or until retirement.

Wearaway

According to Dr. Jack VanDerhei of

Temple University, wearaway can occur when a defined benefit plan based

on final average salary is converted to

a cash balance plan. According to

VanDerhei, at the time of conversion,

the initial value of a participant’s cash

balance account may be set at less than

the value of benefits accrued under the

previous plan. It is important to note

that this does not reduce or take away

previously earned benefits; the accrued

value under the previous plan is guaranteed. What may happen, however,

is that some workers will not accrue

additional benefits until pay and interest credits under the new plan bring

their cash account balance up to the

value already earned under the old

plan.18 This period of no additional

benefit accrual is the wearaway period.

Benefit formulas that result in periods of no new accruals for some employees have been approved by the Internal Revenue Service (IRS) for many

years. Current law requires employers to notify plan participants of any

CHART 2. An example of how hypothetical traditional defined benefit and cash

balance pension plans build value over an employee's career

Cash balance plan

Traditional defined benefit plan

Rate of benefit accrual

SOURCE: Employee Benefits Research Institute

Age of employee

amendment that will result in a significant reduction in the rate of future

benefit accruals. However, employers

are not required to provide individual

notices for each plan participant; nor

do they have to explain the effect that

plan amendments will have on individual participants. This is a concern

for some participants. They argue that

the wearaway period during a conversion should be explained, and a meaningful comparison between projected

benefits under the amended plan and

the benefits that would have been

earned under the previous plan formula should be provided to each

worker.19

Regulatory requirements

From a legal standpoint, cash balance

plans are currently governed by the

same rules that govern traditional defined benefit plans under the Employee

Retirement Income Security Act of

1974 (ERISA). ERISA requires private employers to fully fund their pension plans. A pension plan that is considered fully funded is one with assets

equal to or greater than the amount

needed to provide each plan participant with the pension benefit to which

he or she is entitled. Generally, cash

balance plans require no contributions

from employees.

In 1999, the IRS imposed a freeze

on new approvals of cash balance

plans. The IRS was able to do this

because the agency has jurisdiction

over the finances of such plans because company contributions are tax

deductible. The manner in which

some companies moved to a cash balance arrangement has resulted in

much controversy. The first companies to make the switch were doing

so without offering older employees

any choice. Employees within a few

years of retirement could possibly experience significant reductions in the

level of their benefits under the new

arrangement. Some employees have

instituted class-action lawsuits against

employers and filed Equal Employment Opportunity complaints alleging

illegal reduction of pension benefits.

They have argued that they were not
8 Compensation and Working Conditions Summer 2000

S. 1429

The Taxpayer Refund Act contains disclosure requirements to ensure that plan

participants understand changes to their pension plan and have the tools to determine the effects of those changes on their retirement benefits.

H.R. 2759

H.R. 2759 would require employers that sponsor defined benefit pension plans to

offer all vested employees the right to remain in the plan as it existed prior to any

plan amendment reducing future benefit accruals. This participant consent requirement is imposed not merely on conversions to cash balance plans but on all

defined benefit plan changes that reduce future accruals.

H.R. 1102

Section 407 of H.R. 1102 would ensure that employees affected by a cash balance

conversion receive a notification and description of any significant reduction in

their benefits, rather than a copy or summary of the technical plan amendment that

results in this reduction.

S. 1600

The Older Workers Pension Protection Act is designed to prohibit the “wear-away”

effect. It would ban the practice of applying an amended benefit formula to the

years of an employee’s service that accrued before the amendment. It would instead mandate that benefits earned under the pre-amendment formula would be

added to any benefits earned after the amendment.

S. 659/H.R. 1176

The Pension Right to Know Act would require employers to provide employees

with detailed, individual benefit calculations and projections when certain changes

are made to a pension plan. Under this Act, employers would have to project

benefits for four points in time: 3, 5, and 10 years after the conversion date, and at

the employee’s normal retirement age. All employees’ pay levels are assumed to

increase annually at the average of the last five-year’s increases in the Consumer

Price Index. For these projections, all other relevant factors would remain at conversion date levels. Statements showing benefit amounts (for each of 20 scenarios) would have to be given to the employee at least 15 days before the effective

date of the amendment.

H.R. 2902

According to H.R. 2902, if a company makes a change to its defined benefit pension plan that could result in reduced future benefits (even a change having nothing to do with a conversion to a cash balance plan), the company would have to

offer all vested employees the option of rejecting the new plan and remaining

under the existing plan.

receiving adequate information about

the new plans. The initial response by

employers was to offer older, career

employees an option of remaining in the

original plan or “grandfathering” their

accrued benefit in the original plan to

the new cash balance plan. This required adjusting their pattern of benefit accrual under the new plan so that

benefits at retirement would be similar to those they would have received

under the old plan. These issues have

led to the introduction of legislation

in Congress that would give plan participants a legal right to know when a

change in determining pension benefits will result in a reduction of future benefits. (See box on relevant legislation.)

On another front, the Pension Benefit Guaranty Corporation (PBGC), the

agency charged with insuring qualified defined benefit plans and administering seriously underfunded plans

when necessary, is experiencing difficulty determining how to insure cash

balance plans. These plans present the

PBGC with a challenge because the

benefits are not expressed in terms of

an actuarially computed future

monthly benefit expected from the

plan. Instead, the benefit is expressed

as a lump sum to be paid immediately—not at some future date. Another problem the PBGC faces is determining the amount the organization

can afford to guarantee. Guarantee

limits are set based on the number of

workers eligible to retire at any given

time. Cash balance pension plans

make setting guarantee limits impossible because all plan participants are

technically eligible for retirement once

they have met any vesting requirements imposed by the plan.20

Data analysis

An examination of 1997 EBS data

suggests some of the similarities and

differences between cash balance plans

and traditional defined benefit plans.

Provisions common to defined benefit

plans include, among others, vesting

requirements, eligibility requirements

for plan participation, normal and

early retirement requirements, methRELEVANT LEGISLATION

ods of benefit distribution, and benefit formulas.

Vesting. Vesting refers to the amount

of time a participant must work before earning a nonforfeitable right to

a pension benefit. Once the worker is

vested, the accrued benefit is retained

even if the worker leaves the establishment before reaching retirement age.

A common practice among defined

benefit plans is “cliff vesting.” This

method of vesting is predominant in

traditional defined benefit plans, with

96 percent of participants in these

plans having a cliff vesting schedule

(usually the employee becomes 100-

percent vested after 5 years).21 Similarly, 91 percent of participants in cash

balance plans also had this type of vesting schedule.

Graduated vesting. Graduated vesting, on the other hand, is not as prevalent in defined benefit pension plans

as it is among defined contribution

retirement plans. With graduated vesting, participants earn a portion of their

accrued balance sooner than they

would under a cliff vesting schedule.
 Compensation and Working Conditions Summer 2000 9

Cash Balance Pension Plans

ings formulas, and dollar amount formulas. The terminal earnings formula

is the most prevalent means of determining retirement benefits; more than

half of defined benefit plan participants have a plan that uses this type

of formula.23 According to the EBS,

in 1997, 35 percent of participants in

plans with a terminal earnings formula

received a flat percentage per year of

service, which averaged 1.48 percent.24 As mentioned earlier, this percentage is applied to a much higher

level of earnings than is seen under a

cash balance format.

Retirement age. Based on the structure of cash balance plans, the notion

of normal and early retirement is not

relevant. This is due to the fact that

participants in cash balance plans may

terminate employment and take their

unreduced accrued benefit with them

once they have met any vesting requirements imposed by the plan, or

they may leave the benefit in the plan

allowing it to earn interest credits. In

contrast, traditional defined benefit

plans specify retirement requirements.

The most prevalent normal retirement

requirement for defined benefit plans

is age 65, regardless of the number of

years of service. “Normal retirement”

refers to the age at which an individual

may retire without a reduction in benefits. In 1997, 48 percent of all participants in defined benefit plans had

a normal retirement requirement of

age 65. Of this 48 percent, more than

half (29 percent) had no additional

service requirement attached to the age

requirement. The predominant early

retirement requirement was age 55

with 10 years of service. Early retirement provisions describe the earliest

time at which an individual may terminate employment and receive a retirement benefit, albeit reduced in

some manner.25

Portability and distribution. Differences between traditional defined benefit plans and cash balance plans also

exist in the portability and distribution

provisions. As discussed earlier, distributions from cash balance plans usuThe fact that graduated vesting is used

more often in cash balance plans may

lend some credence to the notion that

these plans have features similar to

those of defined contribution plans.

Data show that 3 percent of participants in traditional defined benefit

pension plans had a graduated vesting schedule as opposed to 33 percent

of participants in defined contribution

plans. Within defined benefit pension

plans, a higher percentage (9 percent)

of cash balance plan participants than

of traditional pension plan participants

had a graduated vesting schedule.

Contributions. The practice of contributing to a cash balance plan at a

higher rate than is customary with terminal earnings formulas may be based

on the level of earnings to be considered in the calculation of the benefit.

Because cash balance arrangements

take into account earnings over the

career of an employee, employers must

contribute at a higher rate to account

for early years of employment during

which earnings are typically lower.

Terminal earnings formulas, on the

other hand, cover a period during

which earnings are theoretically highest (during the last few years just prior

to retirement). Among participants in

cash balance plans, 31 percent had a

benefit that was determined at a rate

ranging from 7.00 to 7.99 percent of

earnings (3 percent of participants

were receiving less than 2 percent of

earnings). (See table 1.) The average

annual employer contribution to cash

balance plan accounts was 5.91 percent.22 In addition, table 2 shows that

a significant number of participants in

cash balance pension plans (44 percent) earned annual interest credit between 6.00 and 6.99 percent. The average rate of interest earned by all cash

balance plan participants in 1997 was

6.58 percent.

Earnings formulas. In defined benefit plans, the benefit formula describes

the method of determining a

participant’s benefit at retirement.

Typical benefit formulas include terminal earnings formulas, career earnally are offered in the form of a lumpsum payment, although these plans are

legally required (as defined benefit

plans) to offer an annuity option. Conversely, the distributions from a traditional defined benefit plan usually are

offered in the form of a lifetime annuity, with options of purchasing some

level of survivor annuity. In 1997, 22

percent of all defined benefit plan participants had an option to take their

entire accrued benefit in the form of a

lump sum, compared with 80 percent

of all cash balance plan participants.26

(See table 3.)

In terms of portability, traditional

defined benefit plans tend to express

portability provisions as transfer of

service credits from one employersponsored plan to another, and not as

a withdrawal or transfer of the accrued

benefit. Eight percent of defined benefit plans provided this concept of

portability in 1997.27 Cash balance

plans, on the other hand, speak of

portability as a withdrawal or rollover

of the accrued benefit into another

qualified plan or into an IRA. It is,

in fact, the portability and distribution provisions that cause cash balance

plans to look like defined contribution

retirement plans.

Summary

Cash balance defined benefit plans (as

well as other types of hybrid defined

benefit plans) are beginning to receive

increased attention. Available literature indicates that transitions appear

to be largely aimed at making employers more attractive to workers who do

not plan to remain with the same employer for their entire career. A cash

balance defined benefit plan promises

these workers a larger benefit than they

would receive under a traditional defined benefit pension plan, as well as

a benefit accrual pattern that may be

better understood.

The following are some of the features of cash balance defined benefit

pension plans.

• The employer bears the investment risk.
10 Compensation and Working Conditions Summer 2000

• In most cases, the employer

makes all of the contributions to

the plan.

• Participants’ benefits are determined utilizing a defined formula.

• Plans are governed by ERISA,

and are insured by the PBGC.

• Plans include many of the same

features offered in traditional defined benefit plans.

• Vesting requirements must be met.

Both lifetime and survivor annuity options must be offered.

• In most cases, the employee can

opt to take the entire accrued

benefit in the form of a lumpsum payment.

A few fundamental questions remain to be answered regarding cash

balance plans. Among these is how

the PBGC will insure these plans given

that all vested participants (regardless

of age) are “eligible to retire.” Transition issues continue to prompt congressional legislative proposals to govern both these plans and the transition

from more traditional defined benefit

plans. Finally, uncertainty still exists

regarding the issues of disclosure and

wearaway. These concerns must be addressed by employers planning a transition to a cash balance defined benefit pension plan.

1

 The Pension Benefit Guaranty Corporation (PBGC) protects the retirement income of

about 43 million American workers in more than

40,000 defined benefit pension plans. PBGC is

a Federal Government corporation established by

Title IV of the Employee Retirement Income

Security Act (ERISA) of 1974 to encourage the

growth of defined benefit pension plans, provide

timely and uninterrupted payment of benefits, and

maintain pension insurance premiums at the lowest level necessary to carry out the Corporation’s

obligations. 2

 These numbers include not only active workers but also retirees (or their surviving spouses)

and separated vested participants. 3

 Pension Insurance Data Book (Pension

Benefit Guaranty Corporation, 1998), p. 5. 4

 Alan L. Gustman and Thomas L. Steinmeier,

Pension incentives and job mobility (Kalamazoo,

MI, W.E. Upjohn Institute for Employment Research, 1995), p.1. 5

 Ibid., pp.40-41.

6

 Jack VanDerhei, “Statement Before the Senate Health, Education, Labor, and Pension Committee,” Hearing on Hybrid Pensions (Employee

Benefits Research Institute, Sept. 21, 1999), p. 7. 7

 Employee Benefits in Medium and Large

Private Establishments, 1997, Bulletin 2517

(Bureau of Labor Statistics, September 1999),

p. 103. 8

 The Bureau’s Employee Benefits Survey

(EBS) covers the incidence and characteristics of

employee benefit plans, and is conducted jointly

with the Bureau’s Employment Cost Index Survey. The two surveys cover all private sector establishments (except farms and private households) and State and local governments.

The EBS covers full- and part-time employees in the 50 States and the District of Columbia.

However, industrial and establishment-size coverage varies on a rotating basis. In even-numbered

reference years, EBS data were collected for small

private establishments (those employing fewer

than 100 workers) and State and local governments (regardless of employment size). In oddnumbered reference years, data were collected for

medium and large private establishments (those

employing 100 or more workers). 9

 “US move towards cash balance plans gathers pace,” Pensions International (London,

Dominus Publishing, Ltd.,June 1999), p. 13. 10 Carol Quick, “An Overview of Cash Balance Plans,” EBRI Notes (Employee Benefits

Research Institute, July 1999), p. 4. 11 “Employee Tenure Summary,” USDL:

98-387 (Bureau of Labor Statistics, Sept.

23, 1998). 12 Current Population Survey (CPS) tenure

data suggest how long workers have been with

their current employer. They say nothing about

how long workers eventually will be with their

current employer. Information on eventual tenure is far more relevant for assessing mobility than

is information on current tenure. Unfortunately,

no direct measure of eventual tenure exists. Because no satisfactory measure exists to quantify

worker mobility directly, CPS data on workers’

tenure with current employers often have been used

to make inferences about worker mobility. However, using CPS tenure data to assess mobility may

lead to incorrect conclusions. 13 “Cash Balance – the benefit of cash balance

plans,” The Association of Private Pension and

Welfare Plans, on the Internet at http://

www.appwp.org/cashbalancenov399.htm (visited June 6, 2000). 14 Kyle N. Brown, Gordon P. Goodfellow,

Tomeka Hill, Richard R. Joss, Richard Luss, Lex

Miller, and Sylvester J. Schieber, The Unfolding

of a Predictable Surprise: A Comprehensive

Analysis of the Shift from Traditional Pensions

to Hybrid Plans (A Watson Wyatt Worldwide

Research Report), Executive Summary, p. 2, on

the Internet at http://www.watsonwyatt.com/

homepage/us/res/cashbalexs.pdf (visited

June 2, 2000). 15 Carol Quick, "An Overview of Cash Balance Plans," p. 8.

According to the Bureau’s 1998 Current

Population Survey, average job tenure for women

16 years of age and older is 3.5 years versus 4.0

years for men in the same age group. 16 Carol Quick, “Cash Balance Plans,” p. 4.

17 Ibid., p. 5.

18 Jack VanDerhei, “Statement Before the Senate,” p.12. 19 Ibid., p. 13.

20 Mark Nance, “What Is A ‘Cash Balance’

Plan, and Why Is Everyone So Excited About

Them?” (Pension Benefit Guaranty Corporation,

1999), pp. 19-23. 21 Employee Benefits in Medium and Large

Private Establishments, 1997, p.112. 22 Data derived from Employee Benefits

Survey, 1997. 23 Employee Benefits in Medium and Large

Private Establishments, 1997, p. 103. 24 Ibid., p. 104.

25 Ibid., p. 109.

26 Ibid., p. 106.

27 Ibid., p. 113.

•
 Compensation and Working Conditions Summer 2000 11

Cash Balance Pension Plans

TABLE 1. Contribution rate of employers offering cash balance defined benefit plans for full-time employees in medium and large

private establishments, selected occupational groups, 1997

Number of workers (in thousands) .............................................. 1,091 502 246 343

Percent of workers with a cash balance plan ............................... 100 100 100 100

Percent contributed

Less than 2.00 .................................................................................. 3 3 6 (1

)

2.00 – 2.99 ........................................................................................ 8 3 4 19

3.00 – 3.99 ........................................................................................ 5386

4.00 – 4.99 ........................................................................................ 20 20 29 13

5.00 – 5.99 ........................................................................................ 5583

6.00 – 6.99 ........................................................................................ 8 10 4 8

7.00 – 7.99 ........................................................................................ 31 39 16 31

8.00 – 8.99 ........................................................................................ 12 10 16 11

9.00 – 9.99 ........................................................................................ 5456

10.00 or more .................................................................................... 2 4 - 2

Not available ..................................................................................... 1 - 5 1

Average percent contributed per year of service .................................... 6656

TABLE 2. Interest earned on accounts in cash balance defined benefit plans for full-time employees in medium and large private

establishments, selected occupational groups, 1997

Number of workers (in thousands) .............................................. 1,091 502 246 343

Percent of workers with a cash balance plan ............................... 100 100 100 100

Interest rate

5.00 – 5.99 ........................................................................................ 24 18 41 20

6.00 – 6.99 ........................................................................................ 44 57 37 29

7.00 – 7.99 ........................................................................................ 6 5 1 10

8.00 – 8.99 ........................................................................................ ---- 9.00 – 9.99 ........................................................................................ 7 - - 22

10.00 or more .................................................................................... 8 10 4 8

Not available ..................................................................................... 12 9 18 11

Average earned interest rate .................................................................. 7667

TABLE 3. Percent of cash balance defined benefit plan participants with lump-sum benefit options, full-time employees in medium

and large private establishments, selected occupational groups, 1997

 Number of workers (in thousands) ............................................ 1,091 502 246 343

 Percent of workers with a cash balance plan ............................ 100 100 100 100

Lump sum available ............................................................................... 80 85 91 67

 Limited to specified amount ............................................................. 6 4 8 8

 No limited amount ............................................................................ 74 81 83 59

No lump sum available .......................................................................... 20 15 9 33

All

employees

Occupational group

Professional,

technical, and

related

Clerical

and

sales

Blue collar

and

service

Employer contribution

2

1

Occupational group

Blue collar

and

service

Clerical

and

sales

Professional,

technical, and

related

All

employees Earned interest rate

1

 The average includes all covered workers; workers without the

plan provision are excluded.

 NOTE: Because of rounding, sums of individual items may not

equal totals. A dash indicates no employees in the category.

 1 Less than 0.5 percent. 2 The average includes all covered workers; workers without the

plan provision are excluded.

NOTE: Because of rounding, sums of individual items may not

equal totals. A dash indicates no employees in the category.

Occupational group

Professional,

technical, and

related

Clerical

and

sales

All

employees Blue collar

and

service

Lump-sum availability