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Employee Benefits

Employers Seek Benefits In Cash Balance Pensions

Much maligned a few years ago, cash balance plans now have a chance to be a useful cost-cutting tool for pension plan sponsors.

Cash balance plans are on the verge of a comeback. More firms with old-style pensions will consider converting to these “hybrid” plans in the next year or two because the IRS now has a roadmap for employers to follow to ensure that they don’t run afoul of age discrimination laws.

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Switching a firm’s pension to a cash balance plan instead of just freezing the pension has this advantage: A pension’s otherwise big, ongoing legacy costs decline more rapidly in a cash balance plan because benefits typically are paid out in a lump sum at retirement, removing each participant from the company’s books as he or she retires.

The key to more cash balance plan conversions is a set of IRS rules that will be finalized in the next couple of months. The rules will show employers what they need to do when converting to insulate themselves from charges that the plans are age discriminatory. A great rush to convert isn’t likely because some pension sponsors will probably wait to see how the early adopters fare. They may worry that the plans will still carry the taint of past legal battles over age discrimination. As one expert put it, all you’d need is for one employee to Google “cash balance plans” and read about the old lawsuits to have a raft of employee complaints on your hands. Even if the complaints aren’t justified, they could mean time-consuming headaches.

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A cash balance plan is known as a “hybrid” because it looks like a 401(k) but operates more like a traditional pension. With a hybrid, a participant’s benefits are determined on the basis of the value of a hypothetical account to which contributions and earnings are added -- on paper. Like a traditional pension, the benefit is supplied solely by the employer, but unlike a regular pension, cash balance participants accrue benefits evenly over time, while a defined benefit plan’s payment is usually based on a participant’s salary in the final years of his or her service. Conversions a number of years ago spawned legal battles, with courts split over the question of whether the plans ran afoul of age bias rules.

To end the uncertainty, the Pension Protection Act of 2006 clarified that cash balance plans aren’t inherently age discriminatory, and the IRS’ rules fill in the blanks on what employers need to do to be sure the plans pass muster. “There had been a regulatory haze before,” says Kevin Wagner, a retirement practice director with Watson Wyatt Worldwide. Wagner says he believes that the 2006 law and subsequent IRS rules “will give us an end to uncertainty around key issues.”

Under the soon-to-be-finalized regulations, companies switching over to cash balance plans must make sure that long-time workers don’t lose benefits as a result of the switchover. And plan participants must be fully vested in their accrued benefits after three years of service. The rules also give guidance on how to calculate interest credits in determining benefit accruals.

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