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Jordan Goodman is the author of Everyone's Money Book, available at 888-201-6300. This is the third edition of the book. You can also visit his Web site at www.moneyanswers.com. He talks with us on Thursday mornings.
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December 19, 2002
"Cash Balance vs. Defined Benefit Pensions"
Last week, the Treasury Department issued new regulations which will allow
many more companies to convert traditional defined benefit pension plans to
cash-balance plans, and the move is provoking a huge controversy between
employer and employee groups.
First, a definition of the difference between the two types of plans and
how it affects what you get from your pension in retirement:
- Traditional defined benefit plans offer retirees a monthly pension based on
their years of service at the company and pay level in the last few
years at the company before they retire. Therefore, most of the value of the
pension accrues in the final years of the worker’s service because that is
when they are most highly paid.
- Cash balance pension plans stipulate that your employer contributes a
percentage of your paycheck to the pension fund each year, and guarantees
that the money will grow at a specific interest rate -- usually, the rate on
Treasury bonds.
The controversy is that traditional defined benefit plans reward older,
longer-term employees by giving them much bigger pensions. Cash balance
plans are better for younger workers because they have more years for the
interest to accrue, and the plans can be carried from one employer to
another. When a traditional defined benefit plan is converted to a cash
balance plan, older workers can lose hundreds of thousands of dollars in
pension payments that they had been expecting, and they have become enraged
as a result.
Hundreds of companies have converted their defined benefit plans to cash
balance, usually as a way to save hundreds of millions of dollars. The furor
boiled over in 1999 when IBM decided to do it, and the IBM employees rose up
in revolt. At that time, the IRS decided to impose a moratorium on approving
new conversions until they had studied the issue -- and the regulations they
just put out lift that moratorium. Employees had been suing, saying that
conversions to cash balance plans were a violation of age discrimination
rules because they impacted older workers so negatively.
The new rules set conditions that companies must follow to make conversions
legal and not in violation of age discrimination rules. The rules say that a
conversion is OK if the percentage of the paycheck contributed by the
employer is no less of older workers than for younger workers. As long as
the employer uses a "reasonable" interest rate assumption in determining the
value of a cash balance account, the conversion is fine, even if benefits are
reduced.
Employers love this new rule interpretation because it means they can now
convert to cash balance plans under clearly agreed guidelines -- and they are
expected to do so by the hundreds. They also argue that more employers will
offer cash balance pensions than would ever offer defined benefit plans.
Employee and pension-rights advocates and AARP are against the rule because
they think it will mean far leaner pension payments for millions of
Americans.
So, what can you do? Take a look at your company’s pension plan, and if they
are considering a switch to cash balance, educate yourself and your fellow
workers -- and make your voice heard so that older workers are not hurt too
badly. One good Web site with loads of information is www.cashpensions.com, which started with the IBM worker’s revolt.
For More Financial Tips From Jordan Goodman
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