Private Pensions:

Implications of Conversions to Cash Balance Plans

HEHS-00-185: Published: Sep 29, 2000. Publicly Released: Sep 29, 2000.

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Pursuant to a congressional request, GAO provided information on the implications of converting traditional private pensions to cash balance plans, focusing on: (1) the prevalence and major features of cash balance plans, and reasons why firms adopt them; (2) how the use of cash balance plans affect the pension benefits for workers of different ages and tenure, particularly after conversion; and (3) what information employers converting to cash balance plans typically provide to plan participants and how disclosure might be improved.

GAO noted that: (1) GAO's survey of 1999 Fortune 1000 firms indicates that the number of firms sponsoring cash balance plans has increased within the last few years, with few firms sponsoring such plans prior to the early 1990s, but increasing to about 19 percent of all Fortune 1000 firms this year; (2) these plans cover an estimated 2.1 million workers; (3) firms in many sectors of the economy sponsor these plans but greater concentrations are found in the financial services, health care, and manufacturing industries; (4) about 90 percent of the firms GAO surveyed that sponsor such plans previously covered their workers under a traditional defined benefit plan; (5) most of the conversions occurred within the past 5 years; (6) key reasons firms gave for converting include lowering total pension costs, adding a lump sum feature to increase the portability of pension benefits, thereby improving the firm's ability to recruit more mobile workers, and facilitating communication of the value of plan benefits; (7) as with traditional pension plans, cash balance plan designs vary significantly; (8) conversions to cash balance plans can be advantageous to certain groups of workers, for example, to those who switch jobs frequently, but can lower pension benefits for others; (9) cash balance plans provide a larger share of a participant's accumulated benefit earlier in a career, compared with a traditional defined benefit plan that is based on final average pay; (10) as a result, conversions can increase the value of some workers' benefits, especially younger or short-tenured workers who leave firms before retirement; (11) unlike traditional defined benefit plans, cash balance plans can result in a declining rate of normal retirement benefit accrual over time; (12) this declining accrual rate can result in older workers receiving lower benefits at retirement from a cash balance plan than they would have from a traditional final average pay plan if it had not been converted; (13) current disclosure requirements provide minimum standards for the information plan sponsors must give participants about plan changes; (14) GAO found wide variation in the type and amounts of information workers receive; (15) the communications provided to employees vary from general statements about plan changes to specific examples of how a conversion to a cash plan might affect workers of different ages and tenure; and (16) often, sponsors did not ensure that participants received sufficient information about plan changes that can reduce future benefit accruals.

Matters for Congressional Consideration

  1. Status: Closed - Implemented

    Comments: In 2003, the House of Representatives considered provisions to amend the Employee Retirement Income Security Act of 1974 that would protect older workers' benefits, including preventing "wearaway periods" when workers accrue no new pension benefits for a period of time, by requiring that companies changing to a cash balance plan give older workers the choice between the old plan and the new cash balance plan.

    Matter: To better ensure continuity of pension accruals for workers affected by conversions to cash balance formulas, Congress should consider amending the Internal Revenue Code and ERISA to establish requirements to prevent firms that convert to cash balance plans from creating a wearaway period at conversion on the value of prior accrued benefits on an annuity and lump sum basis.

  2. Status: Closed - Implemented

    Comments: The Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16), enacted in June 2001, amended ERISA and the Internal Revenue Code to require additional disclosure to plan participants in instances where a plan amendment will result in a significant reduction in future benefit accruals, and includes a penalty for failure to provide such notice. The law expanded the current ERISA notice provision to require disclosure when early retirement benefits are reduced.

    Matter: To improve disclosure related to pension plans, Congress should consider amending the Employee Retirement Income Security Act of 1974 (ERISA) so that it specifically requires firms to provide participants with more timely information, in plain language, about plan changes that can reduce future pension benefits. Such notice could be provided to employees no less than 90 days before the effective date of the plan amendment rather than the current 15-day time frame. This notice requirement could also be expanded to include instances when a plan amendment will significantly reduce or eliminate early retirement benefits.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: To implement new plan disclosure provisions contained in the Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16), the Internal Revenue Service in 2003 issued final regulations on the notice plan administrators must provide to participants when plan changes will result in a significant reduction in future benefit accruals or reduce early-retirement benefits. Because both IRS and DOL regulate ERISA and because these regulations address our recommendation, DOL does not anticipate changes.

    Recommendation: The Secretary of Labor should direct the Assistant Secretary of the Pension and Welfare Benefits Administration, under authority as provided by ERISA, to amend the disclosure requirements for summary plan descriptions and summaries of material modifications to plans to clearly identify the potential of the conversion to reduce future pension accruals and early retirement benefits and under what circumstances such reductions are likely to occur.

    Agency Affected: Department of Labor

  2. Status: Closed - Not Implemented

    Comments: In November 2000, the Department of Labor sought public comment on whether, and to what extent, changes to the summary plan description requirements would help ensure better communications with participants about cash balance plans. DOL also sought views on whether standardized language should be developed for the disclosure of such information. DOL officials said that they received no comments in response to these invitations and that DOL does not intend to change to the summary plan description requirements at this time.

    Recommendation: The Secretary of Labor should direct the Assistant Secretary of the Pension and Welfare Benefits Administration, under authority as provided by ERISA, to amend the disclosure requirements for summary plan descriptions and summaries of material modifications to plans to include a clear statement regarding the hypothetical nature of cash balance accounts, including that employees do not own the accounts, and how such accounts differ from any defined contribution accounts an employer may also provide.

    Agency Affected: Department of Labor

  3. Status: Closed - Implemented

    Comments: IRS issued proposed regulations relating to cash balance plans in December 2002, including how to determine the rate of benefit accrual under such plans. However, in the FY2004 Consolidated Appropriations legislation (P.L.108-199), the Congress prevented the Treasury Department from issuing final regulations on cash balance plans and instead required Treasury to propose legislation to address concerns about older workers affected by cash balance plan conversions. In 2004, Treasury issued its cash balance plan legislative proposal. Cash balance plan conversion issues are currently under consideration by the Congress.

    Recommendation: In clarifying the regulatory treatment of cash balance and similar hybrid plans, the Secretary of the Treasury should direct the Commissioner of Internal Revenue to define the accrued benefit provided by cash balance plans under the framework for hybrid pension plans.

    Agency Affected: Department of the Treasury

  4. Status: Closed - Implemented

    Comments: In February 2004, the Department of the Treasury issued a legislative proposal to address cash balance plan conversions. Among other provisions, the proposal would ban "wear away" of retirement benefits and clarify treatment of cash balance plans under age-discrimination rules. All proposed changes would be effective prospectively from enactment of the proposal. Cash balance plan conversion issues are currently under consideration by the Congress.

    Recommendation: In clarifying the regulatory treatment of cash balance and similar hybrid plans, the Secretary of the Treasury should direct the Commissioner of Internal Revenue to develop a regulatory framework that--where appropriate on issues under its authority, including coordination with other appropriate agencies such as the Equal Employment Opportunity Commission--provides requirements on key issues for cash balance and similar formulas, recognizing the hybrid nature of these new plan designs.

    Agency Affected: Department of the Treasury

  5. Status: Closed - Implemented

    Comments: The Internal Revenue Service (IRS) continued its moratorium on approving cash balance plan conversions while it developed regulatory guidance for employers adopting new cash balance plans, and clarified the status of existing cash balance plan conversions. IRS issued proposed regulations relating to cash balance plans in December 2002, and reviewed public comments. However, in the FY2004 Consolidated Appropriations legislation (P.L.108-199), the Congress prevented the Treasury Department from issuing final regulations on cash balance plans and instead required Treasury to propose legislation to address concerns about older workers affected by cash balance plan conversions. In 2004, Treasury issued its cash balance plan legislative proposal and IRS is continuing its moratorium on approving cash balance plan conversions.

    Recommendation: To address the continuing regulatory uncertainty concerning cash balance and other hybrid designs, the relevant federal agencies should take steps to clarify how these plan designs will be treated under current pension law. Specifically, the Secretary of the Treasury should direct the Commissioner of Internal Revenue to continue the effective moratorium on determination letters approving conversions to cash balance or similar hybrid plan designs until the Internal Revenue Service acts on GAO's recommendations by promulgating regulations addressing key issues concerning these plans.

    Agency Affected: Department of the Treasury

  6. Status: Closed - Implemented

    Comments: To implement new plan disclosure provisions contained in the Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16), the Internal Revenue Service in 2003 issued final regulations on the notice plan administrators must provide to participants when plan changes will result in a significant reduction in future benefit accruals or reduce early-retirement benefits. As part of these regulations, IRS included standardized language and examples to illustrate the new disclosure requirement. Because both IRS and DOL regulate ERISA and because these regulations effectively address our recommendation, DOL does not anticipate changes.

    Recommendation: The Secretary of Labor should also direct the Assistant Secretary of the Pension and Welfare Benefits Administration to develop standardized language that firms may use to meet the amended disclosure requirements.

    Agency Affected: Department of Labor

 

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