Cash-balance conversion called harmful by GAO

Older workers are hit hardest when employers convert traditional pension plans into cash-balance plans, but younger workers, who in theory should benefit, don’t do much better.

Those are the hard-hitting conclusions of the General Accounting Office, the investigative arm of Congress, in two reports on cash-balance plans released late last month.

The studies also said that employers converting their plans seldom spell out the full impact of these changes, adding to the confusion at companies that have switched.

The reports had been requested by Sen. Charles E. Grassley, R-Iowa, chairman of the Senate Special Committee on Aging, and three Democrats in the House – Robert E. Andrews of New Jersey and Major R. Owens of New York, both members of the House Education and the Workforce Committee, and William J. Coyne of Pennsylvania, a member of the House Ways and Means Committee.

The reports come out even as the Senate is deliberating on a pension package that could cement the standing of cash-balance plans. The package would also make it harder for participants to sue employers for age discrimination.

“Unlike traditional defined-benefit plans, cash-balance plans can result in a declining rate of normal retirement benefit accrual over time. The 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,” the GAO report on the implications of conversions states.

The other report has to do with implications for retirement income.

In traditional pension plans, workers earn the bulk of their benefits at the end of their careers. For that reason, workers who quit their jobs before they reach retirement age often earn only a small pension benefit. And most workers must wait until they are 65 to collect their pension checks.

Wearaway woes

But in cash-balance plans, the benefits that workers earn are spread out evenly over their careers. And the plans are more portable than traditional defined-benefit plans. But workers in their 40s and 50s lose out because they have fewer working years left to build up their account balances.

The workers who tend to do better under cash-balance plans are those who stay at a company for at least 10 years – a 30-year-old who quits a job after 10 years collects a lump sum about 11/2 times what he would from a traditional pension plan, the GAO found.

But few employers vest employees earlier than five years, and young workers seldom stay on a job long enough to fully vest.

The GAO also acknowledges that job hoppers are more likely to receive higher total retirement income if they switch to employers with cash-balance plans rather than those with traditional pension plans.

Moreover, older workers tend to be hurt more by “wearaways,” or periods during which they do not earn any new benefits, when their companies switch to cash-balance plans, the GAO states.

Most of the firms the GAO surveyed provide the workers with some sweeteners to soften the blow of the changes, but the extent of the sweeteners varies.

As a result, the GAO recommends that lawmakers adopt changes in the federal pension law and the tax code banning companies from creating such pension plateaus when they switch to cash-balance plans.

But the agency did not stipulate whether that ban should extend to wearaways of subsidized early-retirement benefits, through which most older workers tend to suffer the biggest losses of their pension benefits. A provision in the big pension package has come under fire from participants’ groups because it is silent on the issue of subsidized early-retirement benefits.

What’s more, almost half of the Fortune 1,000 companies with cash-balance plans that the GAO surveyed did not tell workers that their accounts are theoretical only, according to the GAO report on the implications of cash-balance plans for retirement income.

“None of the documents Fortune 1,000 companies with cash-balance plans provided to plan participants that we reviewed provided an explanation of the difference between the accrued benefit and the hypothetical account balance. Participants would need such information to assess accurately the impact of career decisions on their pension benefits,” the GAO report states.

The agency found that about 19% of the nation’s largest companies had cash-balance plans.

Because of the vagaries of interest rates, participants in cash-balance plans may sometimes collect more than what they build up in their paper accounts, but pension law forbids them from ever receiving less than what is in their accounts.

But the GAO’s recommendation that lawmakers amend federal pension law to require employers to give workers better information about changes made to pension plans is nothing new.

In fact, a provision in the pension package being considered in the Senate would require employers to give workers an “estimation tool kit” including software or calculation instructions.

Such tools would let participants figure out their benefits under the traditional pension plan and under the cash-balance plan.

Current law states that employers must simply give workers a notice, at least 15 days before the changes become effective, that they could see a cutback in future benefits. The law does not require employers to say anything about the possible loss of early retirement benefits.

The GAO specifically recommended that the Labor Department ensure that employers clearly tell their workers that the individual accounts provided under cash-balance pension plans are on paper only and very different from those employees own under 401(k) plans.

The GAO also recommended that the IRS stop approving new cash-balance pension plans until it issues regulations spelling out that these plans are, in fact, distinct from traditional defined-benefit pension plans or defined-contribution plans. Because of the controversy, the IRS informally stopped approving conversions last October. The agency, however, has not stopped giving the green light to new plans.

The GAO also proposed that regulators define the accrued benefit provided by cash-balance plans under the new framework it lays out for hybrid plans.

Employers and pension consultants suggest (and the pension package passed by the Senate Finance Committee in early September proposes) that this be defined as the account balance that participants accrue in their paper accounts.

Critics of cash-balance plans say that since such plans are technically defined-benefit plans, rules for such plans should apply and the accrued benefit should be defined as an annuity at age 65.

Not surprising, even before the reports were officially released, proponents and critics had begun using the reports to buttress their views.

Praise on two sides

Those representing participants note that the reports are critical of cash-balance pension plans; employer groups celebrate their emphasis on the need for prompt regulatory action to develop new rules.

“I applaud the GAO for calling on the IRS to suspend cash-balance pension plans until there are more comprehensive worker protections in place,” says Sen. Tom Harkin, D-Iowa, who is a vocal critic of cash-balance plans and who introduced legislation on these plans last year.

But Mr. Grassley is not happy. In two scathing letters to David Walker, the head of the GAO, the Iowa Republican criticized the analysis of the investigative agency as faulty.

The agency, in analyzing accrual rates, used a mathematical model that assumed the affected worker spent his entire career at one job.

Charles A. Jeszeck, a GAO analyst who worked on the reports, says the analysis for the rate of accrual was based on work done outside that mathematical model.

“Within the model, all that we concentrate on are the issues of conversion, and what is important is just the age at conversion,” he explains.

The reports’ findings on disclosures have also come under criticism from some employer groups for being based on summary-plan documents alone, which are perfunctory documents.

The findings also fail to take into account the detailed communication packages many employers have given workers about the changes.

Mark Ugoretz, president of the Erisa Industry Committee, a Washington-based employer group, says he is “not displeased” with the report because it vindicates employers, who have been asking regulators for guidance for years. Mr. Ugoretz hopes the reports will prod the agencies into issuing rules. Critics say the rules are a reason why many small businesses do not offer pensions to their workers.