Cash Balance Conversions

Assessing the accounting and business implications. Wishing to attract younger talent and control costs, companies have been redesigning their defined benefit pension plans. An estimated 16% of Fortune 100 companies have switched to a so-called cash balance formula. Some of the new cash balance plans allow employees to take lump-sum distributions. This appeals to the typical member of today's younger and increasingly mobile workforce, who may not stay with a company long enough to enjoy the full benefits of a traditional pension plan. Congressional concerns about cash balance conversions focus on whether companies are adequately disclosing to participants the resulting changes in benefits and whether cash balance formulas discriminate against older employees. This has led the IRS to mandate that all determinations and examinations of cash balance conversions be forwarded to the IRS National Office for review. In informal discussions, the IRS has indicated it might withhold approval of all pending conversions to give the agency time to formulate a policy on qualification issues. In addition, the Equal Employment Opportunity Commission is considering whether conversions violate the Age Discrimination in Employment Act. Many companies have made the transition to a cash balance plan (for details on how some of them went about it, see "Staying Off the Cover of Time" on page 31). A company considering whether a cash balance conversion is in its best interest should understand * How cash balance pension plans differ from both traditional defined benefit and defined contribution plans.  How a participant's opening account balance and subsequent benefits are determined.  What the accounting and disclosure implications are of a conversion.  How converting to a cash balance formula affects the company's projected benefits obligation, annual pension cost and funding requirements.  What business and employee-relations issues lead employers to switch to cash balance plans. NAME THAT PENSION The addition of cash balance plans essentially has added a third option for companies to choose from in providing benefits to their employees. Defined benefit plan. Under a defined benefit plan, a company promises to pay an employee a specified retirement benefit. The benefit is the amount the employee is deemed to have earned during his or her employment. Employer contributions usually are placed in a trust and invested; benefits are paid from the trust's accumulated assets. The employer's annual contribution is actuarially determined based on employees' ages and salary histories, mortality rates, the performance of the trust's investments and ERISA contribution requirements. The employer bears the financial risk if the investment return on plan assets falls short of expected performance or if trust assets are not adequate to meet the promised benefits. Traditional defined benefit plans are "backloaded"--benefits generally relate to time in service and salary levels immediately before retirement. Thus, a significant portion of an employee's pension benefits accrues in the last 5 to 10 years of employment. Defined contribution plan. Under a defined contribution plan, employees are not guaranteed a specific benefit. Instead, an individual account is maintained for each participant. A participant's account balance is based on * Amounts contributed by the employer and/or employee. * Investment experience on these amounts.  Forfeitures allocated to the accounts. When a fully vested participant retires or withdraws from the plan, the amount allocated to his or her account represents the accumulated benefits the company must pay to the participant or use to purchase a retirement annuity. Benefits are not guaranteed and the participant bears all investment risks. The benefits a participant receives generally are not determined until he or she withdraws from the plan or retires. …

Field of study: Business