Retirement Experts Offer Their Views on Cash Balance Pension Plans

Cash balance pension plans have become a hot topic among employers in recent months. HR Hub Managing Editor Christine Woolsey recently interviewed two leading experts, Dominick Cardace and Norman Clausen, both principals in the retirement practice at PricewaterhouseCoopers/Kwasha HR Solutions, about the basics of cash balance plans and trends occurring in the pension plan arena.

HR Hub: Briefly describe what a cash balance pension plan is and how it differs from traditional pension plans.

PWC Kwasha: A traditional pension plan promises to pay you a specified monthly income at retirement. For instance, if you work for a company for 30 years and retire at age 62, a typical plan might pay you 35% of the average monthly salary you receive during your last five years of employment.

A cash balance plan looks like a 401(k) savings plan but is, in fact, a pension plan. A typical cash balance plan maintains an account in your name, and adds 5% of your salary to this account every year. The plan also adds interest to the account. When you retire, you can usually elect to be paid your account in a lump sum, or elect monthly income payments of equivalent value.

HR Hub: When did plan sponsors first begin adopting cash balance pension plans?

PWC Kwasha: Bank of America was one of the earliest companies to adopt a cash balance plan in 1985.

HR Hub: What are the primary advantages to cash balance plans vs. traditional final average pay plans or other models?

PWC Kwasha: Traditional plans are designed to reward employees who spend their entire career with one employer. Benefits from such plans paid to employees who work for the company only five or 10 years are typically minimal.

Cash balance plans are designed to reward employees for each year of service. This concept of "equal pay for equal work" has two consequences. First, employees who stay with a company for only five or 10 years receive a much more valuable benefit under a cash balance plan. Second, employees who spend their entire career with one company typically receive a smaller benefit than they would have under a traditional plan.

HR Hub: Given the increased mobility of today's workforce, are cash balance plans becoming more popular?

PWC Kwasha: Yes. In the past, an employer's philosophy was that employees should spend their careers at a company until they reach age 60 or 65, and then retire. Today, more employers are adopting a different philosophy that says an employee should remain with the company as long as the employee provides value to the company and the company provides value to the employee.

If an 80-year-old can provide value, he or she should remain employed; if a 30-year-old can't, he or she should seek employment elsewhere.

A cash balance plan supports and reinforces this philosophy, which is why it is becoming more and more popular.

HR Hub: If this philosophy appeals both to workers and employers, why have cash balance plans become such controversial issue?

PWC Kwasha: Because when converting a traditional plan into a cash balance plan, generally some employees will fare better under the new plan and others will fare worse. Most employers recognize that employees whose benefits decrease are essentially receiving a reduction in their future compensation, but regard such cuts as a business necessity.

Many employees, on the other hand, regard the change as the breaking of an unseen contract that they entered into with the employer when they came to work, and which they have, for their part, partly fulfilled.

HR Hub: What factors should employers consider before switching to a cash balance pension design?

PWC Kwasha: The primary purpose of any pension plan is to reward employees for certain behavior. If an employer decides that a cash balance plan better rewards the behavior it seeks from its employees, it should move to implement one, at least for employees to be hired in the future.

But because traditional pension plans are so poorly understood by most employees, employers must carefully weigh the disruptive impact of changing pension plans for the current workforce. Extra transitional benefits are almost always desirable, but their cost can outweigh the benefits of changing the plan.

HR Hub: Are cash balance plans more advantageous to certain types of workers -- young vs. old, for example? Are they more appropriate for certain types of companies -- those with young, mobile workers vs. an aging population?

PWC Kwasha: Age is less of a factor than mobility. Cash balance plans are more advantageous to mobile workers than to employees who spend their entire career with one company. This is why financial institutions, with their large mobile workforces, have been on the forefront of adopting these plans.

HR Hub: For employers switching to cash balance, is it advisable to grandfather certain employees who may not fare as well under this plan design?

PWC Kwasha: When a traditional plan is converted into a cash balance plan, it's common to make sure employees who are close to retirement will receive at least what they would have received under the traditional plan. This is usually a fairly inexpensive provision that avoids potential employee disruption and discontent.

HR Hub: What are the risks involved in grandfathering employees?

PWC Kwasha: Unfortunately, it's only a short-term solution and doesn't address the concerns of employees who are farther from retirement. Typically, the cost of grandfathering many employees becomes prohibitive. These costs are a common reason why employers that are considering cash balance plans eventually decide not to adopt them.

HR Hub: What are the typical costs associated with converting to a cash balance plan and how can employers minimize those costs?

PWC Kwasha: The largest cost is the expense of providing transitional benefits to employees whose cash balance benefit will be smaller than that provided under the traditional formula. If there is less of a need for transitional benefits to make certain employees "whole", the conversion will be less expensive.

HR Hub: Are there employee communication challenges involved in converting to a cash balance pension plan?

PWC Kwasha: Yes. Pension benefits are one of the least understood benefits the employer offers. And for good reason -- since employees have so many more immediate matters to occupy their attention, such as health care.

First, an employer converting to cash balance must convince employees that this is a matter deserving their attention. They also must communicate the fact that the changes are necessary and appropriate for the business, and that the change treats individual employees fairly.

HR Hub: Are these types of pension plans subject to any unique regulatory requirements employers should be aware of? Is there any legislation pending that would impact these plans?

PWC Kwasha: Like all qualified retirement plans, there is a host of regulatory requirements that cash balance plans must comply with and there are likely to be future changes in these requirements.

However, despite the rhetoric from some sources, cash balance plans accomplish so much social good that we can't conceive of legislation that would prevent the development of these plans. The best defense against future legislation, we believe, is complete, honest disclosure of the impact of any change in plan benefits.

HR Hub: Are cash balance plans considered the future of pension plan design?

PWC Kwasha: We expect to see more employers adopt cash balance over the next 10 years. Beyond that, who knows what the needs of the typical employer in 2010 will be?

Mr. Cardace can be reached via e-mail at dominick.cardace@us.pwcglobal.com; Mr. Clausen's e-mail is norman.clausen@us.pwcglobal.com.