Could this be the death knell for cash-balance defined contribution pension plans?
Late last week, a U.S. district court judge in the Southern District of Illinois ruled that IBM’s revamped pension plan violated age discrimination provisions of the Employee Retirement Income Security Act.
Under IBM’s plan, first changed in 1995, pension benefits would accumulate steadily each year, rather than growing slowly early in employees’ careers and accelerating rapidly in their final years of employment.
“This ruling affects not just IBM’s pension plan, but the pension plans of more than 400 major U.S. companies,” said J. Randall MacDonald, a senior vice president (human resources) at IBM.
Mind you, Big Blue is not the only high-profile corporation that has moved to a cash-balance plan over the past few years. Other reported embracers of cash-balance plans include AT&T Corp., Eastman Kodak Co., Cisco Systems, Microsoft Corp., and Electronic Data Systems Corp..
In fact, in a press release, IBM management cited Federal Reserve Board data showing that cash balance plans account for 25 percent of all participants in defined benefit plans and 40 percent of all assets invested in defined benefit plans.
About 19 percent of the 1,000 largest U.S. companies had such plans in 1999, according to the Associated Press, citing a federal government report. Last year Watson Wyatt Worldwide found that 33 of the largest 100 corporations have instituted such plans.
In court, lawyers for IBM argued that the company switched to a cash-balance pension to help keep pace with the shifting career patterns of the technology industry’s younger and more mobile workforce.
IBM announced it will appeal the decision. “IBM’s plan always provides older employees with benefits of equal value or greater value than the benefits earned by younger employees,” the company’s management asserted in a statement. “Neither the plaintiffs nor the judge ever disputed that fact. To call such a plan age discriminatory makes no sense and ignores the fundamental principle of the time value of money.”
Under traditional pension plans, the retirement benefits of workers increase at a much faster rate during their last years of service because workers generally make more money near the end of their careers. The big criticism of cash-balance plans is that if such plans are instituted right as experienced workers approach retirement age, companies will deprive those employees of anticipated gains and leave them without enough working years to accrue equivalent cash balance benefits.
But pension experts say the ruling by the federal court could severely undermine the U.S. pension system.
“This ruling has the potential to cause great harm to the U.S. private pension system,” claims Eric Lofgren, global director of the benefit consulting group at consultancy Watson Wyatt Worldwide. “Moreover, two other district courts and the U.S. Treasury Department have previously reached the opposite conclusion concerning the validity of cash balance plans.”
According to Logren,, one of two possible scenarios will likely occur. Most likely, the U.S. Appeals Court will reverse the ruling. Barring that, a large number of plan sponsors will freeze their defined benefit plans and offer their employees only a 401(k) plan.
Of course, as Lofgren points out, a mass movement to DC plans would shift all of the investment risk onto employees. “Tens of millions of employees could ultimately have reduced benefit security if this verdict isn’t corrected,” argues Lofgren.