A wearaway can affect participants who retire early as well as those who retire at the "normal retirement age" (typically 65). This is especially true if the old benefit formula provided a subsidized early retirement benefit before the conversion. In such a case, a participant who qualifies for the early retirement subsidy (before or after the conversion) might experience a period of years after conversion in which continued service for the plan sponsor generates no net increase in the early retirement benefit. This freeze of early retirement accruals would continue for as long as the new-formula (cash balance) benefit the participant would receive at early retirement age remains less than the old-formula benefit she would receive at that age.
Older participants commonly will have more to lose from wearaway of subsidized early retirement benefits than from wearaway of the normal (typically age 65) retirement benefit. There may be more dollars at stake, and most employees retire before age 65.
Wearaway is neither required nor necessary in a conversion. In any event, because wearaway is always based in part on age, it runs afoul of the prohibitions against age discrimination. A plan sponsor can, and often does, prevent wearaway by providing that the ultimate plan benefit is the sum of the participant's benefits accrued under the traditional plan (the old formula frozen benefit) and the cash balance formula. (This is often referred to as the "sum-of" or "A+B" approach.)
A typical cash balance formula provides for a much larger accrual of benefits at an earlier age than a traditional defined benefit plan. Since a younger employee has a longer period of time before normal retirement age, the amount in the plan's hypothetical account will continue to earn interest credits for a much longer period of time, leading to greater benefits. Fewer years until normal retirement age means older workers have less compounding and thus smaller benefits.
As a result, the conversion to a cash balance formula has the practical and substantive effect of often dramatically reducing or ceasing accruals to the pensions of older and/or long service workers. Older employees have reported reductions in their expected benefits in the tens and even hundreds of thousands of dollars. In contrast, younger mobile workers, who had accumulated little under the prior plan design, may see a higher accrual rate.
In the early years of the traditional plan, an employee receives small benefits in return for the promise of greater benefits as the employee continues to work. The change in plan design to a cash balance plan undermines completely that benefit trade-off. Older workers find that having completed those years in the traditional plan when benefits were small - and having now reached the stage when benefits will begin to grow considerably - the conversion to the cash balance plan deprives them of those expected higher benefits. These conversions give new meaning to the term "sandwich" generation.
The pension laws generally prohibit plans from reducing accrued benefits that an individual has previously earned. However, the law does not require an employer to continue any particular plan design, nor indeed even continue any plan, into the future. The conversion to a cash balance plan uses this permissive nature of our voluntary pension system in a way that undermines the expectations of employees. Despite having worked for years under a plan design that gave small benefits at the beginning but promised higher benefits at the end of one's career, the same employees are suddenly switched to a pension package that provides the very opposite.