Cash balance pension plans: will the public sector follow the private-sector stampede?

• Author: Owens, Tom

In recent years, cash balance pension plans have become increasingly popular among businesses and other organizations with traditional defined benefit pension plans. As of 1999, more than 300 organizations (including at least three public pension funds - the California State Teachers Retirement System, the Texas Municipal Retirement System, and the Washington State Teachers Retirement System) have placed more than $330 billion in assets into cash balance plans for all or many of their employees.

While public pension funds have not been particularly active in the recent surge in cash balance pension plan conversions, there are signs suggesting that some level of interest might be developing. An increasing number of public pension plans are beginning to examine the applicability of cash balance plans to their systems. Proponents of cash balance plans argue that these plans represent the best hope for reversing the continued shift from defined benefit pension plans to defined contribution plans, while also providing an incentive to attract younger skilled workers. However, critics are voicing strong concerns that the cash balance plan offers employers an avenue to actually cut retirement benefits for those workers nearing retirement. These criticisms have prompted several groups to petition the U.S. Congress to examine cash balance plans and consider possible regulations.

What is a Cash Balance Plan?

In formal terms, a cash balance pension plan is a hybrid plan that encompasses the characteristics of both defined benefit and defined contribution plans. A defined benefit plan offers a specified and guaranteed retirement benefit based upon a formula comprised of length of service and compensation level. The plan sponsor invests the accumulated funds within the plan and also bears the risks associated with those investments. In contrast, a defined contribution plan provides for the establishment of individual accounts for each employee. The plan sponsor regularly contributes a specified amount. Each individual employee is responsible for the investment of his or her account assets and the associated risks. In addition, each individual receives a retirement benefit based upon the investment performance associated with his or her account with no guaranteed retirement benefit level.

Under the law, a cash balance plan is considered a defined benefit plan. It offers employer funding options as well as a guaranteed retirement benefit with no investment risk to the individual employee. However, by design, cash balance plans resemble defined contribution plans insofar as they establish individual accounts and provide regular account statements. These statements provide employees with a snapshot of their accumulated retirement assets at a given point in time. They also contain features that are...