since companies dipped into pension funds in the 1980s to finance
leveraged buyouts have corporate treasurers been so abuzz over a pension
technique." Guess who loses?
AMAZING DISAPPEARING PENSION
||IBM’s July 1 change
in its pension plan became a ringing wake-up call for many of the
company's employees. Faced with the loss of as much as 40 percent of
their pension benefits, IBM workers are seriously looking at union
organization for the first time.
Big Blue’s well-publicized changeover to a cash-balance plan
is also sounding alarms for workers with union-negotiated defined
benefit plans. Companies big and small are converting traditional
pension plans into cash-balance plans.
"What started as a trickle in the 1980s has turned into a
torrent of cash-balance conversions — costing untold thousands of
mid-career employees as much as one-half of their expected
pensions," says the AARP.
An estimated 500 plans covering as many as 3 million workers have
been converted to cash-balance plans in recent years. "Not since
companies dipped into pension funds in the 1980s to finance leveraged
buyouts have corporate treasurers been so abuzz over a pension
technique," reports the Wall Street Journal.
|UNDERSTANDING CASH BALANCE
Cash-balance plans combine features of defined-benefit
and defined-contribution plans.
A defined-benefit pension plan pays out a specified amount based
on a predetermined formula. In most traditional defined-benefit plans, benefits
are figured on the basis of service and final years of pay. A
defined-contribution plan — a 401(k), for example — provides an individual
account for each participant, based only on money contributed or allocated to
At the same time, cash-balance plans function like
defined-contribution plans. "In a cash-balance plan, the company makes a
defined contribution into an individual retirement account for each worker, and
promises that the cash balance in that account will ‘earn’ a specific
interest rate each year," explains UE Research Director David Alexander.
These accounts exist only on paper, however. Employers pool
these "accounts" for investment.
As with defined-contribution plans, the benefits provided by
cash-balance plans are portable.
That portability — and the relatively rapid accrual of
benefits — makes cash-balance plans attractive to low-service and younger
workers, particularly those workers who aren’t expecting a long career with
the same company. For example, a 28-year-old worker earning $34,000 a year could
walk away from a job after six years with close to $10,000 in pension benefits.
The same features of cash balance that seem attractive to
younger workers now is what has long-service IBM and other workers up in arms.
And today’s twenty-somethings may find themselves shortchanged as they
Cash-balance plans offer career-average pensions — workers
earn benefits linked to their current pay, averaged over their careers. This is
in sharp contrast to the traditional defined-benefit pension plans that are a
feature of UE contracts with General Electric and many other major employers. In
these plans, benefits are determined by a formula that typically combines years
of service with average pay in the last few years of work. Since pay is usually
highest in the final years, workers in these plans earn most of their benefits
towards the end of their working lives. Long-service workers are rewarded with
The conversion from traditional defined-benefit plans is
devastating the retirement plans of many middle-aged and older workers, with
losses of future benefits ranging from 20 to 50 percent. The conversions are
occurring just as these workers reach the age where the old formula began to
sharply raise the value of their future pension payouts.
Are cash-balance conversions motivated by employer attempts to
rid themselves of long-service workers and decent pension benefits?
That assertion is strengthened by reports that a leading
benefits consulting firm markets an "Aging Diagnostic" to help
employers evaluate the cost of providing pensions to their work forces.
IBM hired that firm, Watson Wyatt Worldwide, to evaluate the
impact of employees’ ages on its pension plan. IBM converted its traditional
pension plan to a cash-balance plan in July.
"I am deeply concerned that serious age discrimination may
be taking place," says U.S. Sen. Paul Wellstone (D., Minn.), who has called
for an investigation of cash-balance plans.
"In my opinion, every single cash-balance plan... violates
the age-discrimination," said pension lawyer William K. Carr in comments to
the publication Pensions & Investments. Carr has represented
plaintiffs in several lawsuits against companies that have switched to
"It’s the amazing disappearing pension," comments Stephen
Langlie, a 37-year employee of the Onan Corp., who saw his future benefit
slashed from $1,100 to $424 a month. Onan is a Minnesota subsidiary of Cummins
Bill Syverson, a 49-year-old senior engineer for IBM was
looking forward to a pension of $40,000 a year when he retired after 30 years’
service. Conversion to cash balance plan sliced that figure in half.
Here’s how conversion works: An opening account balance for
each participant in a cash-balance plan is determined by computing the present
value of the participant’s accrued pension benefit under the old plan.
Under law, workers are not supposed to lose any of the benefits
that have accrued under the old plan, but future benefits are not protected. In
conversions, long-service workers have not been getting the full value of their
accrued defined benefit during the conversion process. And they are finding out
that they may have to stay on the job longer to obtain benefits they once
expected under the old pension plan.
"Some companies use one set of assumptions to figure the
older worker’s lump sum for termination, but a worse set of assumptions to
figure out the cash balance to put into the worker’s new account,"
observes UE’s Alexander. "It might take years of additional
service to earn back the value of their built-up benefit at the time of
The process is confusing enough that many workers don’t learn
until long after the fact how much they have lost as a result of cash-balance
Tapes of actuaries discussing cash balance that were played at a
recent Congressional hearing illustrate the danger for workers — and benefits
to employers. "Converting to a cash-balance plan does have an advantage as
it masks a lot of the changes," says a Pricewaterhouse actuary.
"It is not until they are ready to retire that they understand how
little they are actually getting," says a Watson Wyatt Worldwide
actuary, while another comments: The law doesn’t require you to say the words,
"your rate of future-benefit accrual is being reduced."
The corporate cash-balance craze is the latest assault on
decent, employer-funded retirement income. Companies have been steadily pushing defined-contribution
plans, such as 401(k) as a substitution for defined-benefit plans which
provide a more reliable form of retirement income.
"One might get the impression, from the rise of 401(k)
retirement plans, that pensions are a dead species," said the Wall
Street Journal last year. "In fact, nearly all large employers still
have pension plans." With millions of baby-boomers moving into their peak
pension-earning years, corporations are looking for a way of avoiding their
pension obligations. The Wall Street Journal suggests that some companies
are adopting cash-balance plans as an alternative to terminating pension plans
Company spokespersons and corporate apologists insist that
cash-balance conversions are taking place mostly to improve employee benefits.
And some companies say the new plans are designed to appeal to younger,
technologically skilled workers in a tight labor market. But it is clear that
the benefits to corporate bottom lines are enormous.
"Companies like these plans because it means they will
never face the roll-up that comes with defined benefit plans — there
is no increase in their pension costs for past service when workers
negotiate higher wages or multipliers," says David Alexander. "If
workers negotiate a higher contribution rate or higher interest rate, it will
affect only the employer’s cost for future service, not past service as well.
"Companies also like the plans because they get to keep any
interest earned on workers’ money above the established rate," Alexander
continues. "If they play the markets well, the plans become self-funding.
For these and other reasons, cash balance plans tend to be cheaper for companies
than defined benefit plans."
IBM anticipated savings of $200 million a year from its
cash-balance conversion. The Central and Southwest Corp. saved $20 million in
pension costs the first year of conversion to cash balance. The year before, CSW
had to set aside $30 million to fund its pension obligations. Once it made the
switch, it didn’t have to advance a dime to fund the pension plan.
The new scheme, the Wall Street Journal report says, is
"a restructuring that often makes it unnecessary ever to feed the plan
"The potential for using a cash-balance plan as a
restructuring tool may be one reason it is gaining favor throughout corporate
America," Michael J. Gulotta, chief executive officer of the consulting
firm Actuarial Sciences Associates, wrote last year.
Controversy over cash-balance conversions and their adverse
impact on long-service workers, especially after the well-publicized IBM
conversion, has fueled calls for greater government scrutiny.
The Internal Revenue Service has ordered field offices to confer
with national headquarters before approving any new cash-balance plans. This
directive, issued in mid-September, came after U.S. Rep. Bernie Sanders (I.,
Vt.) obtained an internal IRS memo raising questions about possible age
discrimination in the plans.
A bill introduced by Sanders (HR 2902) would ensure that
employers have a choice when companies seek to implement a cash-balance plan.
That bill is now before the House Ways and Means and Education and Workforce
Choice is also stressed in legislation introduced by Sen. Paul
Wellstone (D., Minn.) "Congress must act now to put transition safeguards
in place to protect the retirement security of the American worker,"
Wellstone said. His bill would ensure workers’ right to know as well as a
choice between pension plans.
Sen. Wellstone’s legislation would prevent company pension
plans from giving participating employees an opening account balance that is
lower than their already accrued pension benefits to date under the old plan —
what’s known as "wear-away."
Meanwhile, various bipartisan bills and legislation introduced
on behalf of the Clinton Administration would provide some guarantees that
workers have the legal right to know when changes in pension plans reduce
benefits. The Clinton bill has been slammed as "too little too late."
Karen Friedman of The Pension Rights Center said the Administration’s Pension
Reduction Disclosure Act is the equivalent of the "useless surgeon general’s
warning;" it informs workers that cash-balance plans "may be hazardous
to their wealth, but offers them no protections."
If the employer talks about switching to a cash-balance plan:
• Demand all the facts. How much money will
the employer save? How will more senior workers’ pensions be affected?
Workers facing a conversion to a cash balance plan can exercise their rights
to receive a statement of their "vested accrued benefit" and compare
it to the starting cash balance the company wants to put into their accounts.
• Become educated. Understand how the
new plan would really work.
Remember, employers cannot change the pension without
bargaining with the union.
Cash-balance accounts are attractive to short-service workers
because of the greater accrual on the short-term, amounts expressed as lump sums
which can be transferred from job to job. But what happens if today’s
short-service worker becomes tomorrow’s long-service veteran of the same
He or she may well be shortchanged by a cash-balance pension
Over the long term and after a certain age, cash balance offers
less than traditional defined-benefit plans. The benefits of long service built
into the traditional plans can dramatically exceed the payout promised by cash
A number of major corporations will have laughed all the way to
the bank again and again before a generation of workers discovers how their
retirement prospects have been undermined by the trend to cash balance.
According to Labor Dept. statistics, half the workforce is 38.2
years old, the highest median age for workers in several decades — and that
median is expected to hit 40.6 in 2006. Half the workers between 35 and 44 years
are staying five years on their jobs, compared with 2.7 years for those in 25 to
34 age group. The Labor Dept. says mobility is no greater for people now over
age 40 than for their parents’ generation.
Ironically, due to the sharp drop in the birth rate after the
post-World War II baby boom, many companies might be forced into retaining older
workers rather than forcing them out the door. "That makes you wonder how
long the cash balance fad will last," muses a leading benefits consultant.
Vigilant union action, ultimately, will be the best means of
ensuring that workers receive the best possible pensions.
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