Ensuring Retirement Income Security with Cash Balance Plans

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Introduction

Airline bankruptcies and the terminations of defined benefit (DB) pension plans at United Airlines and US Airways have garnered the attention of policymakers and the media. Much of the debate focuses on avoiding a domino effect among airlines and preventing a similar future culmination of pension plan failures in other industries. In addition, the conversion of traditional DB plans to so-called cash balance plans will be on the table, too. Increasingly, firms that offer a DB plan have changed the way benefits are calculated to a cash balance plan. These plans combine aspects of DB plans – guaranteed benefits – with aspects of defined contribution (DC) plans, such as 401(k) plans – individual account balances. Cash balance plans may help a more mobile workforce accumulate more retirement savings than traditional plans, but employers may also disguise benefit cuts in the conversion. In particular, these benefit cuts may be bigger for older workers than for younger workers. This is one reason why recent court decisions ruled them age discriminatory, hence requiring congressional clarification of the existing rules.

A closer look at the evidence on cash balance plans shows the following:

• Under the right circumstances, cash balance plans can prove beneficial for workers who are more mobile. Whether they are preferable to a traditional DB plan depends on the particulars of an employer’s workforce.
• As the private sector participation rates in traditional DB plans have stabilized, the coverage by cash balance plans has risen. In 2003, 24.6 percent of all participants in DB plans were covered by hybrid plans, mainly cash balance plans, up from 20.5 percent in 2001.
• Workers’ retirement income security needs to be protected in the conversion of cash balance plans. Substantial transition benefits, most notably the choice between staying in the old plan and being covered under the new one, for all current workers would ensure that benefit accruals wouldn’t be cut.
• Because cash balance plans offer lump sum benefits, the risk of outliving one’s savings also grows. To counter this, tax incentives could be offered if people convert their lump sums into monthly benefits. Such tax incentives should be targeted towards lower and moderate income households who have few savings and they should be offered for all retirement plans.