Opinion ID: 2974994
Heading Depth: 3
Heading Rank: 2

Heading: Whipsaw calculation

Text: The most litigated aspect of cash balance plans has proven to be the so-called “whipsaw calculation.” This calculation arises when participants opt to “cash out” their hypothetical accounts No. 06-3442 West v. AK Steel Corporation et al. Page 4 before they reach normal retirement age. To comply with ERISA, lump-sum payments such as the ones received by the plaintiffs in the present case must be the actuarial equivalent of the normal accrued pension benefit. See Berger v. Xerox Corp. Ret. Income Guar. Plan, 338 F.3d 755, 759 (7th Cir. 2003) (citing 29 U.S.C. § 1054(c)(3)). The actuarial equivalent is calculated in two steps. First, a participant’s hypothetical account balance is projected forward to normal retirement age—in the AK Steel Plan, age 65—using the rate at which future interest credits would have accrued if the participant had remained in the AK Steel Plan until that time. Second, that projected amount is discounted back to its present value on the date of the actual lump-sum distribution. If the interest rate used in Step 1 is greater than the discount rate used in Step 2, the amount of the participant’s lump-sum disbursement will be larger than his or her hypothetical account balance. This two-step process is commonly referred to as the “whipsaw calculation.” In the present case, Opening Accounts receive interest credits at a minimum annual rate of 7.5%, while the statutory discount rate for calculating the present value of a lump-sum distribution has been invariably lower (5.1% in 2002, for example). This causes the value of the pension benefit under the whipsaw calculation to be greater than the simple value of the account balance at the time of the lump-sum distribution. The IRS provides a useful example of the whipsaw effect: A cash balance plan provides for interest credits at a fixed rate of 8% per annum that are not conditioned on continued employment, and for annuity conversions using the [Internal Revenue Code §] 417(e) applicable interest rate and mortality table. A fully vested employee with a hypothetical account balance of $45,000 terminates employment at age 45 and elects an immediate single sum distribution. At the time of the employee’s termination, the Section 417(e) applicable interest rate is 6.5%. The projected balance of the employee’s hypothetical account as of normal retirement age is $209,743. If $209,743 is discounted to age 45 at 6.5% (the Section 417(e) applicable interest rate), the present value equals $59,524. Accordingly, if the plan paid the hypothetical account balance of $45,000, instead of $59,524, the employee would receive $14,524 less than the amount to which the employee is entitled. IRS Notice 96-8, 1996-1 C.B. 359. The plaintiffs argue that ERISA mandates the whipsaw calculation—in other words, a payout of $59,524 in the example cited above—and that AK Steel’s failure to calculate lump-sum distributions in this manner constitutes a statutory violation of ERISA. AK Steel responds by arguing that, under the plain language of the AK Steel Plan, the plaintiffs received exactly the lumpsum distribution to which they were entitled—the value of each participant’s hypothetical account at the date of termination ($45,000 in the example above).