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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 ERISA or
the Internal Revenue Code. If you still have questions, call one of our
offices or email your question to EBSA.
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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.
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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.
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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 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.
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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.
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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.
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Traditional defined benefit pension plans do not offer
this feature as frequently.
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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.
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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.
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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. 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.
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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.
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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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The Department of Labor, the Equal Employment Opportunity
Commission (EEOC), and the IRS/Department of theTreasury have
responsibilities in overseeing and enforcing the provisions of the law.
Generally, the 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.
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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.
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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 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.
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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.
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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 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 (1) the accrued benefit under the
formula in effect before the amendment, and (2) 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.
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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
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Providing no choice, replacing the
old formula and applying the new formula to all participants.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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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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.
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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.
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If your concerns are not adequately addressed, or you
still have questions about your situation, you should contact one of our
offices.
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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).
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