Companies that move from pensions to a cash balance plan can benefit by avoiding the risk of market volatility, but they should explain all aspects of the switch to employees and be careful not to violate the prohibition against age discrimination.
When cash balance accounts replace retirement pensions, employees can be highly sensitive to the loss of retirement options they feel like they earned, and on many occasions they have sued when they perceive problems of new exposure to risk, possible loss of early retirement opportunities and reduced assets for retirement.
The June 22 ruling by the 3rd U.S. Circuit Court of Appeals in Engers v. AT&T, No. 10-2752 (3rd Cir., June 22, 2011), reinforces a plan sponsor’s ability to convert its traditional plan formula to a cash balance plan.
In spite of the favorable ruling for business, this choice remains a contentious, controversial one, not least because of the perception that the switch decreases benefits for the affected plan participants. These participants may sue the plan, and several oversight organizations also keep a watchful eye on the possibility of wear-away in plans.
Because of this, plan sponsors choosing to make this switch should:
- Fulfill all legal requirements concerning benefit accruals, and do not violate the prohibition against age discrimination in making the switch;
- Explain all aspects of the switch (the new cash balance plan and the comparison of benefits under the old plan versus the new plan, for starters);
- Keep a watchful eye for developments on cash balance plans, especially whether conversion to them violates ERISA or federal age discrimination law (the Age Discrimination in Employment Act, or ADEA); and
- It kind of goes without saying to consult an attorney when you do this.
The Decision in Engers v. AT&T
AT&T management employees brought a class action against AT&T’s retirement plan, alleging among other things: (1) older plan participants experienced disproportionately longer wear-away periods, violating the ADEA; and (2) AT&T failed to adequately disclose the mpact of the plan amendments to employees. The case stayed in district court 12 years before it landed in the circuit court.
Wear-away Definition
The U.S. Department of Labor (DOL) describes “wear-away” as instances in which a plan participant’s benefits under the pension formula exceed the amount deemed the correct benefit under the cash balance plan. In such cases, plan participants may not arn additional benefits (but do continue to grow their cash balances) until their benefit under the cash balance plan exceeds what was earned under the old formula.
The Enger court ruled in the company’s favor , holding, among other things, that it was within the plan’s discretionary authority under ERISA to construe plan terms, and that the plan did not abuse its discretion when it originally denied the plaintiffs’ claims.
It agreed with the district court’s assessment that the plan complied with rules outlined in ADEA and that the plaintiffs’ wear-away claims were barred under that statute.
The future of converting a more traditional plan to a cash balance plan will be in the spotlight for some time also due to the U.S. Supreme Court decision in CIGNA v. Amara.