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May 2003
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If
your company is converting its traditional pension plan benefit formula to a
new cash balance pension plan benefit formula, you may have some questions
about how this change will affect you. The following are responses to some
of the most often asked questions. These responses are designed to provide
general information and are not legal interpretations of the Employee
Retirement Income Security Act or the Internal Revenue Code.
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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. For more information on
defined benefit plans and defined contribution plans, you may want to review
the publication What You Should Know About Your Pension Rights.
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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 1-year U.S. 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.
Additional information on vesting and distribution of benefits is in the
publication What You Should Know About Your Pension Rights.
If a participant receives a lump sum distribution, that distribution
generally can be rolled over into an IRA or to another employer's plan if
that plan accepts rollovers. For information on pension rollovers, you may
want to order a copy of IRS Publication 575, Pension and Annuity Income:
Rollovers or Publication 590, Individual Retirement Arrangements (IRAs):
Traditional IRAs - Can I Move Retirement Plan Assets?. To order, call the
IRS toll-free number: 1.800.829.3676.
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 (PBGC).
For more information about this protection, see Your Guaranteed Pension, a
publication of the PBGC, at www.pbgc.gov, or call toll free 1.800.400.7242
to request a copy.
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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.
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Cash balance plans are defined benefit plans. In
contrast, 401(k) plans are a type of defined contribution plan. For an
explanation of defined benefit and defined contribution plans, refer to What
You Should Know About Your Pension Rights.
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. Read Your Guaranteed Pension
for more information on this protection or contact the PBGC.
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Yes. Federal law, including the Employee Retirement
Income Security Act (ERISA), the Age Discrimination in Employment Act (ADEA),
and the Internal Revenue Code (IRC), provides certain protections for the
employee benefits of participants in private-sector pension and health
benefit plans.
The U.S. Department of Labor, the Equal Employment
Opportunity Commission (EEOC), and the IRS/Department of the Treasury have
responsibilities in overseeing and enforcing the provisions of the law.
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/Department of
the Treasury generally focuses on the standards set by the law for plans to
qualify for tax preferences.
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.
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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.
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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 3 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 3 years of compensation when the plan amendment is
effective. This benefit (including related early retirement benefits) is
protected by law and cannot be reduced.
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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.
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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.
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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 (see response
to question 9 above) 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 Pension Rights.
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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.
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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.
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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. For more on how to
obtain information from your plan, review What You Should Know About Your
Pension Rights.
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.
For further information about the waiver of ADEA rights,
you may call the Equal Employment Opportunity Commission’s toll-free
number at 1.800.669.4000 (TDD 1.800.699.6820) or visit www.eeoc.gov.
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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, read Can Your Retiree Health
Benefits be Cut?
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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 the Department
of Labor’s Employee Benefits Security Administration to speak to a benefit
advisors in the EBSA office nearest you. You can reach them by calling toll
free at 1.866.444.EBSA (3272) or electronically at www.askebsa.dol.gov.
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.
For more information on Federal laws prohibiting employment discrimination
contact the EEOC at 1-800-669-4000 (TDD 1.800.669.6820) or visit
www.eeoc.gov.
To obtain copies of What You Should Know About Your
Pension Rights and Can Your Retiree Health Benefits Be Cut?, call
EBSA’s toll-free request line at 1.866.444.EBSA (3272) or view these
publications and others at www.dol.gov/ebsa.
To order Your Guaranteed Pension and to obtain
more information about federally insured benefits, write or call:
Pension Benefit Guaranty Corporation
1200 K Street NW
Washington, DC 20005-4026
Tel 202.326.4000
Toll-Free 1.800.400.7242
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This fact sheet has been developed by the U.S. Department
of Labor, Employee Benefits Security Administration, Washington, DC 20210.
It will be made available in alternate formats upon request: Voice phone:
202.693.8664; TTY: 202.501.3911. In addition, the information in this fact
sheet constitutes a small entity compliance guide for purposes of the Small
Business Regulatory Enforcement Fairness Act of 1996.
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