(Archived Content)
FROM THE OFFICE OF PUBLIC AFFAIRS
JS-172
The American ideal is that everyone should retire with dignity and with the financial security to live out their years in comfort. That ideal depends on a sound pension plan and adequate private savings, complemented by Social Security.
The American workforce has changed dramatically in recent years. No longer do workers spend their entire career at one company. Traditional employer-based retirement plans provide the majority of benefits to employees only after they have worked with that employer for many years. This was a good deal for workers when they tended to stay with a single employer for long periods of time--20 or 30 years. But, these traditional retirement plans are not a good deal for workers who stay for only a few years. This fact has presented challenges for employers and employees in ensuring that retirement savings options are fair for all workers.
Since the majority of the workforce is now far more mobile, one increasingly popular retirement option is called a cash balance plan. A cash balance plan is a type of tax-qualified retirement plan that combines features of a defined contribution plan (like a 401k), with features of a more traditional defined benefit plan. Cash balance plans are better suited to a mobile workforce because employees accrue more substantial benefits earlier in their careers and can take their cash balance plan with them as they move from job to job. They also provide some investment protections similar to a defined benefit plan.
Like a defined contribution plan (like a 401k), cash balance plans provide each employee with an account. The employer credits the account with pay credit contributions (for example, 5 percent of pay) and interest. This allows all employees - regardless of age - to earn benefits evenly over their careers. When workers change jobs, their cash balance plan can move with them. If the new employer doesn't have a cash balance plan, the employee can roll their cash balance plan into an IRA.
But like a defined benefit plan, the employer bears all the investment, or downside, risk for a cash balance plan. This means that the employer always has to make sure that the employee's account has enough to pay out total contributions plus interest - even if the plan investments do not perform well.
This is an added protection for workers over 401k type plans-they don't have to worry that their retirement benefits are going to fluctuate with the markets.
A cash balance conversion occurs when an employer changes from a traditional pension plan into a cash balance plan.
Current law does not prevent companies from converting to cash balance plans, but the law does prevent an employer from taking away or reducing the value of a pension benefit that has already been earned by a worker- whether or not there is a cash balance conversion. A cash balance plan conversion has no effect on current retirees. In addition, the conversion cannot reduce the pension benefits that a worker earned prior to the conversion.
During the 1990s, a number of companies converted their defined-benefit plans into cash-balance plans, prompting charges from older workers that the change violated age-discrimination laws. Three years ago, Treasury and the IRS stopped sanctioning the switch to cash-balance plans until rules could be put in place governing the switch from a traditional pension to a cash-balance plan.
Treasury proposed regulations in December 2002 that would address these issues. The regulations provide important new protections for older workers in a number of ways. They require that any cash balance plan must give older employees pay credits that are equal to or greater than the pay credits for younger employees. Also, the regulations require that any cash balance conversion be age-neutral--which means that employers can't use factors in a conversion that provide a bigger benefit for younger workers than for older workers. The regulations require the plan to be age-neutral before, after, and in the process of the conversion.
The Treasury Department is seeking to ensure that cash balance plans remain a viable option, while ensuring that if a company converts from a traditional retirement plan to a cash balance plan, it does so in a manner that is fair to all its workers.
These reforms are part of the Administration's agenda to preserve defined benefit plans and to provide American workers with necessary protections for their pensions and retirement security.