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Hybrid (Cash Balance) Pension Plans

Testimony Before the Subcommittee On Retirement Security And Aging

Moreover, declining accrual rates in cash balance plans based on age are the diametric opposite of the often increasing accrual rates in traditional defined benefit pension plans. For this reason, conversions to cash balance pension plans can have a dramatic impacts on the retirement security of older employees.


As noted, a wearaway period can occur if, as is often the case, the traditional defined benefit plan 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 the conversion in which continued service for the plan sponsor generates no net increase in the early retirement benefit because the value of the new-formula benefit at early retirement age remains less than the value of the old-formula benefit at that age.

Any cash balance plan legislation should make clear that this type of wearaway period (an "early retirement benefit wearaway") as well as normal retirement benefit wearaway - is prohibited. Early retirement benefit wearaway can affect many participants in converted plans, including those who are subject to a wearaway of their normal retirement benefit. The harm to older workers and the age discrimination concerns raised by the normal retirement benefit wearaway also apply to the early retirement benefit wearaway. Moreover, an early retirement benefit wearaway can continue long past the time when a normal retirement benefit wearaway has ended.

The early retirement benefit wearaway can be prevented by grandfathering or by applying the "sum of" (or "A + B") approach described above to early retirement benefits. (This could be done in tandem with a similar approach to normal retirement benefits or an adequately protective "greater of" approach with an appropriate opening account balance for normal retirement benefits.) As a result, a participant who retired while entitled to a subsidized early retirement benefit under the old formula would receive the sum of that subsidized early retirement benefit annuity and the excess of the cash balance account over its opening account balance (in other words, the subsidized early retirement annuity plus the increase in the cash balance account).

Consistent with the nature of subsidized early retirement benefits, this approach would be contingent. It would not apply unless the participant was entitled to a subsidized early retirement benefit under the terms of the old plan formula at the time the participant took his or her benefit under the converted plan (whether the participant first qualified for the subsidized early retirement benefit before or after the conversion).

The plan sponsor could offer the participant the choice of taking the increase in the account balance as a lump sum, as opposed to taking it in the form of an annuity that is added to the old-formula subsidized early retirement annuity.

Incorporating the value of the early retirement subsidy in the opening account balance would violate the prohibition against age discrimination. If the opening account balance were allowed to incorporate the value of the early retirement subsidy from the old formula, older participants could be given smaller opening account balances - and also smaller lump sum distributions upon retirement -- than otherwise identical younger participants who qualify for the early retirement subsidy. In addition, because the subsidized early retirement benefit is contingent, including the subsidy in the opening account balance of all participants could create substantial windfalls for those participants who ultimately do not qualify to receive the subsidy.

Letter from AARP Group Executive Officer Chris Hansen to the Hon. John Boehner, Chairman for the Committee on Education and the Workforce

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