Monday, September 30, 2013

Cash Balance Pension Plans and Older Workers - Aarp

Cash Balance Pension Plans and Older Workers - AarpIB78 CASH BALANCE PENSION PLANS AND OLDER WORKERS Introduction This Issue Brief discusses issues related to cash balance plan design in the context of both traditional defined benefit (DB) pension plans and 401(k) plans—the most prevalent type of defined contribution (DC) pension plan. Cash balance pension plans combine features of both DB and DC pension plans. How to protect the pension benefits of older workers and whether cash balance plans discriminate against older workers are key issues in the current public policy debate about cash balance plan conversions. What Is a Cash Balance Pension Plan? Because a cash balance pension plan combines features of both a DB and a DC pension plan (Table 1), it is often referred to as

a “hybrid” pension plan (Coronado and Copeland 2003). Pension law, however, treats it as a DB pension plan because the plan specifies a monthly benefit at retirement. Cash balance plans have generally originated from conversions from traditional DB plans. They usually have not been started independently as new plans (U.S. General Accounting Office 2000). Two important attributes of a cash balance plan are: (1) hypothetical or notional individual accounts—a DC feature, and (2) a formula for determining benefits at retirement—a DB feature. Individual Accounts. Unlike a traditional DB pension plan, a cash balance plan provides workers with hypothetical or notional individual accounts (Table 1). Like traditional DB plans, workers are automatically enrolled in cash balance plans. Also like traditional DB plans, cash balance plans are insured by the Pension Benefit Guaranty Corporation. In a cash balance plan, each participant’s account is periodically credited with a dollar amount by the sponsoring employer, usually based on a percentage of the individual’s salary. Although a cash balance plan portrays benefits to employees in the form of an “individual” account, the cash balance account does not depend on the performance of plan assets. Contributions and investment earnings are not actually allocated to individual accounts; instead, contributions are made to a common trust fund for all participants, and benefits are paid directly from the fund. Cash balance plans are similar to 401(k) plans in that they are communicated to workers in terms of a balance in an individual account, they are readily portable, and their benefits are based on earnings over the entire period of participation in the plan. Benefit Formula. The cash balance pension formula determines benefits as a function of wages, pay credit rates, and interest credit rates. Contributions credited to the employee’s account by the employer (pay credit) are generally quoted as a given percentage of the employee’s pay. Interest credits equal to the product of the employee’s credited account balance times an interest credit rate are also accrued in the account (Chart 1). An interest credit rate is either a fixed rate or a variable rate tied to an index, such as the 30-year Treasury bond rate, or the rate on one-year Treasury bills reset every six months. According to the Bureau of Labor Statistics (BLS), the average annual employer contribution rate, i.e., pay credit, to cash balance accounts was 5.9 percent in 1997. The average rate of interest (annual interest...

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