There are two general types of pension plans-Defined
Benefit Plans and Defined
Contribution Plans. In general, defined benefit plans provide a
specific benefit at retirement for each eligible employee, while defined
contribution plans specify the amount of contributions to be made by the
employer toward an employee’s retirement account. In a defined
contribution plan, the actual amount of retirement benefits provided to an
employee depends on the amount of the contributions as well as the gains
or losses of the account.
A cash balance plan is a defined benefit plan that
defines the benefit in terms that are more characteristic of a defined
contribution plan. In other words, a cash balance plan defines the
promised benefit in terms of a stated account balance.
In a typical cash balance plan, a participant's account
is credited each year with a pay credit (such as 5 percent of
compensation from his or her employer) and an interest credit
(either a fixed rate or a variable rate that is linked to an index such as
the one-year Treasury bill rate). Increases and decreases in the value of
the plan's investments do not directly affect the benefit amounts promised
to participants. Thus, the investment risks and rewards on plan assets are
borne solely by the employer.
When a participant becomes entitled to receive benefits
under a cash balance plan, the benefits that are received are defined in
terms of an account balance. For example, assume that a participant has an
account balance of $100,000 when he or she reaches age 65. If the
participant decides to retire at that time, he or she would have the right
to an annuity. Such an annuity might be approximately $10,000 per year for
life. In many cash balance plans, however, the participant could instead
choose (with consent from his or her spouse) to take a lump sum benefit
equal to the $100,000 account balance.
In addition to generally permitting participants to
take their benefits as lump sum benefits at retirement, cash balance plans
often permit vested participants to choose (with consent from their
spouses) to receive their accrued benefits in lump sums if they terminate
employment prior to retirement age.
Traditional defined benefit pension plans do not offer
this feature as frequently.
For more about vesting and distribution of benefits see
What You Should
Know About Your Retirement Plan.
If a participant receives a lump sum distribution, that
distribution generally can be rolled over into an Individual Retirement
Account (IRA) or to another
employer's plan if that plan accepts rollovers. See IRS
Publication 575 Pension and Annuity Income: Rollovers or Publication
590 Individual Retirement Arrangements (IRAs): Traditional IRAs - Can I
Move Retirement Plan Assets? for more information.
The benefits in most cash balance plans, as in most
traditional defined benefit plans, are protected, within certain
limitations, by federal insurance provided through the Pension Benefit
Guaranty Corporation.
While both traditional defined benefit plans and cash
balance plans are required to offer payment of an employee’s benefit in
the form of a series of payments for life, traditional defined benefit
plans define an employee's benefit as a series of monthly payments for
life to begin at retirement, but cash balance plans define the benefit in
terms of a stated account balance. These accounts are often referred to as
hypothetical accounts because they do not reflect actual
contributions to an account or actual gains and losses allocable to the
account.
Cash balance plans are defined benefit plans. In
contrast, 401(k) plans are a type of defined contribution plan.
More about Defined
Benefit Plans and Defined
Contribution Plans.
There are four major differences between typical cash
balance plans and 401(k) plans.
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Participation. Participation in typical cash
balance plans generally does not depend on the workers contributing
part of their compensation to the plan; however, participation in a
401(k) plan does depend, in whole or in part, on an employee choosing
to make a contribution to the plan.
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Investment Risks. The investments of cash balance
plans are managed by the employer or an investment manager appointed
by the employer. The employer bears the risks and rewards of the
investments. Increases and decreases in the value of the plan's
investments do not directly affect the benefit amounts promised to
participants. By contrast, 401(k) plans often permit participants to
direct their own investments within certain categories. Under 401(k)
plans, participants bear the risks and rewards of investment choices.
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Life Annuities. Unlike many 401(k) plans, cash
balance plans are required to offer employees the ability to receive
their benefits in the form of lifetime annuities.
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Federal Guarantee. Since they are defined benefit
plans, the benefits promised by cash balance plans are usually insured
by a federal agency, the Pension Benefit Guaranty Corporation (PBGC).
If a defined benefit plan is terminated with insufficient funds to pay
all promised benefits, the PBGC has authority to assume trusteeship of
the plan and to begin to pay pension benefits up to the limits set by
law. Defined contribution plans, including 401(k) plans, are not
insured by the PBGC.
The PBGC may be contacted at:
Pension Benefit Guaranty Corporation
1200 K Street NW
Washington, DC 20005-4026
Tel 202.326.4000
Toll-Free 1.800.400.7242
Yes. Federal laws, including the Employee Retirement
Income Security Act (ERISA), the Age Discrimination in Employment Act (ADEA),
and the Internal Revenue Code (IRC), provide certain protections for the
employee benefits of participants in private sector pension and health
benefit plans.
If your employer offers a pension plan, the law sets
standards for fiduciary responsibility, participation, vesting (the
minimum time a participant must generally be employed by the employer to
earn a legal right to benefits), benefit accrual and funding. The law also
requires plans to give basic information to workers and retirees. The IRC
establishes additional tax qualification requirements, including rules
aimed at ensuring that proportionate benefits are provided to a
sufficiently broad-based employee population.
The U.S. Department of Labor, the Equal Employment
Opportunity Commission (EEOC), and the Internal Revenue Service (IRS) have
responsibilities in overseeing and enforcing the provisions of these laws.
Generally, the U.S. Department of Labor focuses on the fiduciary
responsibilities, employee rights, and reporting and disclosure
requirements under the law, while the EEOC concentrates on the portions of
the law relating to age discriminatory employment practices. The IRS generally focuses on the standards set by
the law for plans to qualify for tax preferences.
Yes; however, employers are not required to establish
pension plans for their employees because the private pension system is
voluntary. In addition, employers are allowed substantial flexibility in
deciding whether to terminate or amend their existing plans. Therefore,
employers generally may change by plan amendment their traditional pension
plans and the benefit formulas they use.
Federal law does place restrictions on plan changes,
including amendments that convert a traditional pension plan formula to a
cash balance plan formula. For example, a plan amendment cannot reduce
benefits that participants have already earned. Advance notification to
plan participants is required if, as a result of the amendment, the rate
that plan participants may earn benefits in the future is significantly
reduced. Additionally, there are other legal requirements that have to be
satisfied, including prohibitions against age discrimination.
No. While employers may amend their plans to reduce the
rate at which future benefits are earned, they generally are prohibited
from reducing the benefits that participants have already earned. In other
words, an employee generally may not receive less than his or her accrued
benefit under the plan formula at the effective date of the amendment. For
example, assume that a plan's benefit formula provides a monthly pension
at age 65 equal to 1.5 percent for each year of service multiplied by the
monthly average of a participant's highest three years of compensation,
and that the plan is amended to convert its benefit formula to a cash
balance plan formula. If a participant has completed 10 years of service
at the time of the amendment, the participant will have the right to
receive a monthly pension at age 65 equal to 15 percent of the monthly
average of the participant's highest three years of compensation when the
plan amendment is effective. This benefit (including related early
retirement benefits) is protected by law and cannot be reduced.
When an employer amends its plan to convert the plan's
traditional defined benefit plan formula to a cash balance plan formula,
the plan's assets remain intact and continue to back the pension benefits
under the plan. Employers cannot remove funds from the plan, unless the
plan has been terminated and has assets remaining after payment of all of
the benefits under the plan.
In some cases, when your traditional plan formula is
changed to a cash balance plan formula, the benefit earned under the old
formula may exceed the amount determined to be your benefit under the cash
balance plan formula. In this situation, you might not earn any additional
benefits until your benefit under the cash balance plan formula exceeds
the benefit you had earned under the old formula. This is commonly
referred to as “wear away.” There are legal requirements that have to
be satisfied with respect to benefit accruals, including prohibition
against age discrimination. “Wear away” is one of the issues being
closely studied by the EEOC, IRS and the U.S. Department of Labor.
If you have worked long enough to be vested under the
plan, you should receive the sum of:
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The accrued benefit under the formula in effect
before the amendment
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Any additional benefits you earned under the plan
formula in effect after the amendment. However, you may have to wait
until a retirement age under the plan to receive your benefit.
For more about vesting and distribution of benefits,
see What You Should
Know About Your Retirement Plan.
The right choice for you and your family may be
affected by a wide range of factors. For example, in making this choice
you should take into account your retirement expectations, when you intend
to begin receiving your benefits, and the chance that your needs might
change.
In analyzing any choice presented under your plan, you
will want to compare all the terms and options available to you under the
cash balance package with those currently available to you. It is
important for you to consider each option under each plan formula.
You will also want to consider the specifics of your
retirement benefit, such as how your accrued benefit (including the value
of any early retirement subsidy) is defined under each formula, the
current value of your accrued benefit under each formula, and its value as
an annuity at normal retirement age, or as a lump sum distribution. You
may also want to take into account how your choice will affect survivor
benefits.
You should also compare the value of other related
benefits that may be offered under either choice. For instance, some
traditional pension plans provide for an offset or subsidy if you retire
prior to the age at which your Social Security benefits commence, or offer
credit for service also covered by a disability benefit plan.
In making your decision, you should pay attention to
any time limits that may apply and any waivers you may be requested to
sign. Finally, you need to consider how long you have been with your
employer and whether or not you expect to stay employed with your current
employer or change jobs in the future.
You may want to consult a professional advisor for
assistance in making your choice.
Generally, pension plans and health plans are operated
independently and are administered separately. If you have questions about
your health benefits you should contact your health plan administrator. Be
aware that, like pension plans, many health plans can be amended or
terminated.
For more information, see Can
Your Retiree Health Benefits be Cut?
You should immediately contact the plan administrator
and discuss your concerns. Be sure to review your individual benefit
statement or the information used to calculate your benefit to determine
if it is correct such as employment date, length of service, and salary.
If your concerns are not adequately addressed, or you
still have questions about your situation, you should contact one of our
benefit advisors, located in 15 field offices nationwide or contact the EBSA
office nearest you.
In addition, employees who believe that they have been
subject to discriminatory treatment because of their age, race, color,
religion, sex, national origin, or disability may file a charge of
discrimination with the Equal Employment Opportunity Commission (EEOC).
There are strict time limits for filing such a charge.
Neither ERISA nor the IRC requires employers to give
employees the choice of remaining in the old formula. Employers have
several options, including:
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Allowing employees to remain under the old formula,
while restricting new hires to the new formula;
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Stipulating that certain employees who have reached
a specific length of service or who have reached a certain age may
choose to stay with the old formula; and;
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Providing no choice, replacing the old formula and
applying the new formula to all participants.
The law permits employers to have such flexibility, but
whatever option applies has to satisfy legal requirements. For example,
the option may not violate prohibitions against discrimination on the
basis of age.
Under each of these options, benefits already earned by
the participants, as of the effective date of the amendment that converts
the old formula to a cash balance formula, may not be reduced.
Many employers voluntarily provide helpful information
about these conversions in advance of the change becoming effective. Make
sure you have all the information that the employer has provided. If you
are still not sure if you have enough information to understand the plan
change, you have a right to contact your plan administrator and ask for
more information or help in understanding the change and any choices you
have in conjunction with the change.
Plan administrators are required to give at least 15
days' advance notice of plan amendments that significantly reduce the rate
at which plan participants earn benefits in the future.
After the plan is amended, the plan administrator is
required to provide all plan participants with a Summary of Material
Modifications to the plan or a revised Summary Plan Description. This
document will summarize the changes to your plan.
More information about your
right to plan information.
In addition, under the Age Discrimination in Employment
Act (ADEA), an employer requiring an employee to sign a waiver of rights
and claims when choosing between plans is required to provide enough
information to enable the employee to make a knowing and voluntary
decision to waive ADEA rights. In most cases, an employee must be given at
least 21 days’ to sign the waiver and at least 7 days’ to revoke the
agreement.
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