Many employers are replacing traditional pension plans with cash-balance plans—conversions that will accelerate if proposed changes by the U.S. Treasury Department go into effect. Because they accrue benefits at rates different from those of traditional defined-benefit plans, cash-balance plans threaten the retirement security of millions of U.S. working families.
Cash-Balance Conversions Without Protections
Conversion to cash-balance plans is driven by employers’ overriding desire to save money. In a January 2003 Deloitte & Touche accounting firm survey of 80 companies, each employing some 5,000 workers, 40 percent of those offering pension plans say they are seriously considering cutting plan benefits. And many would like to make those cuts by converting their traditional defined-benefit pension plans—now covering approximately 70 percent of union members employed in the private sector and 16 percent of nonunion workers—to so-called cash-balance pension plans.
What’s the Difference Between Defined-Benefit and Cash-Balance Plans?
Under a traditional defined-benefit pension plan, a worker receives a guaranteed monthly benefit at retirement. The amount of the benefit is based on formulas that include such variables as a worker’s age at retirement, rate of pay and number of years worked. Cash-balance plans, technically a type of defined-benefit pension plan, differ from traditional plans because workers can see their individual account balances.
For example, a traditional defined-benefit plan promises workers monthly benefit checks at retirement—say, $800 per month for life at age 65. But a cash-balance plan promises workers an account balance that grows over time—a $25,000 balance as of today, for instance. (While people in cash-balance plans have the legal right upon retirement to convert to an annuity that pays monthly benefits for life, they tend to take the lump sum, which they risk running through after retirement.)
The most important practical difference between traditional defined-benefit plans and cash-balance plans is the accrual rates at which benefits build up over the course of a worker’s career. Under traditional benefit formulas, workers earn most of their benefit toward the end of their careers. In a cash-balance plan, however, a more level share of benefits is set aside throughout a worker’s career.
Cash-balance plans often include special early retirement provisions, a valuable benefit for some that allows workers to collect full benefits at an earlier age if they meet certain requirements such as working a certain number of years and reaching a specific age. Many companies use cash-balance conversions to eliminate early retirement benefits for the future.
However, older workers can be shortchanged when employers convert to cash-balance plans. Because of the difference in accrual rates, plus the possibility that cash-balance opening account balances will not include the early retirement subsidies credited to workers under traditional plans, conversions ultimately can cost older workers tens of thousands of dollars in benefits, according to the U.S. General Accounting Office.
The U.S. Equal Employment Opportunity Commission has received more than 800 employee complaints related to cash-balance conversions. The IRS has not approved any new conversions since 1999 because of concerns regarding age discrimination.
For Union Workers, Cash-Balance Conversions Must Be Negotiated
Through bargaining, unions can prevent conversions or negotiate improvements that make conversions more equitable. Such improvements might include clauses that protect expected benefits for long-term employees, preserve early retirement benefits and other important options and improve contribution formulas.
401(k)s and Similar Plans
Many employers offer 401(k) savings plans to their workers. In addition to 401(k)s, others sponsor similar plans such as 403(b)s and 457s, primarily for government workers.
In these plans, workers each have their own individual account funded with voluntary contributions from their paychecks. Many employers make partial contributions that typically match only part of what a worker has put into the plan, for example 50 cents for every dollar the worker contributes up to worker contributions of 6 percent of pay. Plans are set up so workers get to choose how to allocate their money among different investment choices. Benefits are a function of contributions into an account and investment earnings and losses.
Employers have shifted away from pensions and to 401(k)-type plans because of certain advantages they offer employers. With a 401(k), individual workers are responsible for deciding how to invest their retirement money, and investment risks are born solely by the worker. Losses in the plan simply translate into lower benefits for workers. Workers fund much of 401(k) savings themselves through deductions from their paychecks, and many employers make their contributions entirely in company stock, a practice that is of enormous advantage to companies because it requires no cash expenditure and the company gets a tax deduction for it.
Some employers offer 401(k)s as supplements to company pensions. This is important because pensions may not provide enough money by themselves to stand alone on top of Social Security.
The Union Way
The unions of the AFL-CIO bargain with employers for secure retirement savings plans such as 401(k)s and work to achieve improvements for workers through legislation. Reforms are needed to give workers a right to sell company stock in their 401(k) and other retirement savings plans within a reasonable period of time and to counteract employers’ efforts to induce workers to invest heavily in company stock. Congress should end employers’ exclusive control over workers’ retirement money by giving workers a voice in how 401(k)s are run, and it should enhance workers’ access to conflict-free investment advice.
IRAs
Individual retirement accounts (IRAs) are an important tool helping workers save for retirement outside of work and protect their pension and 401(k) money when they take it out of a retirement plan from a past job. Very few people actually contribute new retirement money to IRAs in any year, and efforts to expand IRAs—particularly increases in the limits on how much money can go into an account—may actually undermine some job-based pensions if business owners and managers see them as a way to save for themselves without giving anything to ordinary workers.
