Personal Finance--A. Crenshaw, The Post:"Pension Trend Painful to Some"
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>>> Pension Trend Painful to Some
By Albert B. Crenshaw
Sunday , October 15, 2000 ; Page H02
Fueled by recent General Accounting Office reports and the ongoing complaints of a number of IBM workers, the debate over cash-balance pension plans shows no sign of abating.
According to the GAO, nearly one in five big employers has changed its pension plan from the traditional form to a cash-balance approach, and many others are studying the idea. Cash-balance plans often are less costly for employers, and many say the plans are advantageous for recruiting young workers. Opponents charge that the plans discriminate against older workers and are a dodge to conceal benefit cutbacks. The critics have taken their case to the courts, the Internal Revenue Service, the Labor Department and Congress, so far with mixed results.
The battle to date has focused mainly on technical issues such as whether cash-balance plans and conversions violate age-discrimination laws, the 1974 Employee Retirement Income Security Act, IRS regulations or other employee protections.
But while individual workers and employers may win or lose on narrow points of law, the battle is really about a couple of much more fundamental questions: What is the future of the nation's pension and retirement income system, and what share of the retirement income risk--that is, the risk that benefits at retirement will not be sufficient--should be borne by the employer and how much by the employee?
A shift in the risk is already well underway. Since the 1980s, employers have been moving toward defined-contribution plans, such as 401(k) plans, and away from traditional pensions, also known as defined-benefit plans.
Many workers, especially younger ones who have lived most of their lives with a buoyant stock market, embrace this change. They understand that through wise investment over many years they stand a chance of becoming wealthy through their retirement plans.
They also are more likely to change jobs in the future, and defined-contribution plans are more "portable," meaning that workers will keep more of their benefits when they change jobs.
Older workers, whose time horizons are necessarily shorter and who probably have seen bad times in the stock market, prefer an old-style pension. And since they are less likely to change jobs, they become increasingly conscious of the benefits such plans give them for long service. Also, if their plan has early-retirement incentives, they may be looking forward to a comfortable income and perhaps even a new job at another company beginning at, say, age 55.
Cash-balance plans, on the other hand, bring to the risk discussion packages that provide defined benefits but look a lot like defined-contribution plans. In a cash-balance plan, typically, the company sets up a hypothetical account for each worker and credits a portion of pay--often 3 percent to 5 percent--to that account each year. In addition, the money in the account is credited with interest each year, often near the long-term Treasury bond rate.
The result is an account balance that rises in a more or less linear pattern over the employee's working life. And since the account can be given out to workers in a lump sum if they go to another job, it is easily portable.
As with a defined-contribution plan, however, workers who change jobs must reinvest these lump sums if they hope to avoid taxes and achieve adequate retirement nest eggs. If they don't, this portability becomes a peril rather than an advantage.
A traditional defined-benefit plan, often called a final-average plan, pays benefits based on a formula involving years of service at the company; average pay in the last few working years; and a percentage factor, typically around 1 percent.
For example, suppose you earned $45,000, $48,000 and $52,500 in your last three years of work, for an average of $48,500, and had worked 30 years for the company. Your annual benefit might look like this:
$48,500 x 30 x 1 percent = $14,550
Under such a formula, benefits accrue slowly at first and then very rapidly as the worker nears retirement, as bigger numbers (rising pay) are multiplied by other bigger numbers (years of service).
Plans that have early-retirement incentives may allow a worker to obtain a full pension at age 55 and 30 years of service. Such incentives were originally designed to speed employees into retirement at a time when workers were plentiful, but many companies now find them counterproductive in a tight labor market.
There is nothing inherently wrong with cash-balance plans, and in fact they can be designed to provide the same benefits to retirees as final-average plans.
It's what companies actually do that's causing the dispute.
Cash-balance plans are rarely if ever started from scratch. They are almost always installed as a conversion of a final-average plan.
Since benefit accrual patterns in cash-balance and final-average plans are reverse images of one another--high in the early years for cash-balance (because the interest is credited over a longer period) and high in the later years for final-average--middle-aged workers can end up with the worst of both worlds. They will have missed the long interest buildup of the cash-balance plan but, because of the conversion, won't get the high-accrual years of the final-average plan.
Most companies take steps to ameliorate the problem. Some give extra credits to older workers or let them remain in the final-average plan. But not all companies do this, and some that do create "cliffs" in which workers who are a few years or even months apart in age end up with quite different benefits.
Workers who were counting on the old plan and find themselves pushed out of it feel angry and betrayed, especially if it had early-retirement benefits.
A second issue arises over a more general shift in benefits away from long-term workers. Since benefits in a cash-balance plan build in a more linear fashion, lower-paid and shorter-tenured workers will get more than under a final-average plan. Unless the employer wants to spend more money on the plan--and many don't--the result is a reduction in benefits to higher-paid and longer-tenured workers.
Studies show that at many companies, the lion's share of the benefits under a final average plan go to a relatively few higher-paid, longer-serving workers. Thus, a cash-balance plan can be viewed as "democratizing" the benefits.
"You take the money you are spending on a very few people and redistribute it throughout the workforce," said Richard Shea, a lawyer at Covington & Burling who has defended employers against age-discrimination suits arising from conversions.
Shea said analyses of the impact of conversion at several companies found that more than three-quarters of the employees leaving the company had better benefits under the cash-balance plan than they would have had under the final-average plan--sometimes 200 to 300 percent better.
The number of workers whose benefits were reduced was much smaller. In dollar terms, however, these reductions were substantial.
In addition, some companies are overtly using the conversion to shift risk onto workers. A senior executive of one large company said recently that it reduced benefits in its pension when it switched to a cash-balance plan and used the savings to improve the 401(k) plan. "We thought our employees ought to be doing more of their own saving for retirement," he said.
The cost to the company was about the same under the new arrangement as under the old, he said, which, while true on a cash basis, overlooks the fact that the workers now bear more of the investment risk and the company less.
The GAO, looking at all this, concluded that cash-balance plans can result in greater retirement income for many workers, provided they invest carefully. But it noted that cash-balance plans "place a greater reliance on personal responsibility and choice."
"Responsibility and choice"--to many that sounds suspiciously like "sink or swim."
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