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Hybrid (Cash Balance) Pension Plans

Testimony Before the Subcommittee On Retirement Security And Aging

Chairman Dewine, Ranking Member Mikulski, distinguished Members of the Subcommittee, I am David Certner, Director of Federal Affairs, of AARP. AARP is a nonprofit membership organization of over 35 million persons age 50 or older, about 45% of whom are still working. AARP fosters the economic security of individuals as they age by seeking to increase the availability, security, equity, and adequacy of pension benefits. AARP and its members have a substantial interest in ensuring that participants have access to pension plans that provide adequate retirement income and that the benefits accrued under a plan are not reduced because of age.


Congress provided a detailed structure in defining retirement plans under ERISA and the Internal Revenue Code ("IRC"). All retirement plans are either defined benefit plans or defined contribution plans, even if they have features of both. A defined contribution (or "individual account") plan provides an individual account for each participant, with the benefits at retirement consisting of contributions the employer and employees have made, plus income and gains, and minus expenses, losses, and forfeitures. [ERISA section 3(34)]. A defined benefit plan is defined as any retirement plan other than an individual account plan. [ERISA section 3(35)]. Traditionally, the benefit at retirement under a defined benefit plan is based on a benefit formula that takes into account years of service and, under many plans, final salary or wages.

Recognizing that defined contribution plans and defined benefit plans—and their methods of accruing or accumulating benefits—are fundamentally different, Congress prescribed a different set of rules for each (including rules governing the timing of benefit accruals, valuation of benefits, certainty of benefit determinations, and expression of accrued benefits). A plan sponsor may not pick and choose which rules to follow, but must follow all the rules depending upon the plan design selected.

Cash balance pension plans (and other plans, such as pension equity plans) are so-called "hybrid" plan designs. Cash balance plans are defined benefit plans that have been designed to resemble defined contribution plans. Instead of presenting the benefit in terms of an annuity payable at retirement, as traditional defined benefit plans do, cash balance plans portray a participant's benefit as a lump sum amount that increases over time, and, in practice, pay most benefits in the form of lump sums.

In most cash balance plans, the benefit is defined by reference to a "hypothetical account." The hypothetical account is credited with an annual pay credit (usually a percentage of pay, such as 5% of pay each year) plus a hypothetical rate of return (usually tied to an index, such as a Treasury bond rate) on the account balance (an "interest credit"). As in all defined benefit plans - and consistent with the hypothetical nature of these "individual accounts" - the employer contributes assets to the plan, the assets are invested for the plan as a whole instead of earmarking particular assets or investments for the individual accounts of particular participants, the employer (including those to whom it delegates) manages the plan, and the employer is permitted flexible funding. This means that, at any given time, there may be more benefits promised in the hypothetical accounts than there are assets in the plan.

The employer's contribution obligation depends upon its estimate of the present value of total future benefit obligations and its investment gains and losses, not on fixed or promised annual contributions to individual accounts.  

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