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CASH BALANCE

CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK.

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CASH BALANCE

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    1. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK Gregory C. Braden Alston & Bird LLP One Atlantic Center 1201 West Peachtree Street Atlanta, GA 30309-3424 404-881-7497 Email: gbraden@alston.com

    3. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK How Did We Get Here? The Essential Premise: The “Accrued Benefit” In A Defined Benefit Plan Has To Be Defined As An Annuity Payable for Life At Normal Retirement Age The Problem It Causes: Cash Balance Plans Express The Accrued Benefit As A Current Account Balance Pay Credits Interest Credits

    4. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK To Get The “Accrued Benefit” You Have To Determine The Normal Retirement Annuity Equivalent Of The Current Account Balance Add interest credits at the current rate for future years to normal retirement age Convert to a life annuity Reduce back to present value to determine lump sum accrued benefit

    5. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK WHIPSAW IRS Notice 96-8; Treas. Reg. 1.411(a)-11(a) Lump sum payment from a cash balance plan requires project forward reduce back calculation. Non-“safe harbor” interest crediting rate can create volatile unpredictable liabilities far exceeding the stated account balance. Which Would You Rather Be? A generous employer subjected to volatile swings in pension liability; or An ungenerous employer who can confidently predict its pension liability?

    6. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK And One Other Thing About Whipsaw . . .

    7. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK AGE DISCRIMINATION ERISA § 204(b)(1)(H): The plan cannot reduce the rate of benefit accrual “because of the attainment of any age.” Plaintiffs’ Theory: To Determine The Rate Of Benefit Accruals You Convert Each Year’s Pay Credits Into A Normal Retirement Annuity Project forward to normal retirement age Convert to annuity The Exact Same Pay Credit Will Always Generate A Higher Normal Retirement Annuity For A Younger Employee So Cash Balance Plans Will Always Provide Lower Accruals for Older Employees and Violate § 204(b)(1)(H)

    8. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK EXAMPLE: Employee A age 35 employed as staff attorney earns $100,000 and participates in employer’s cash balance plan providing 5% pay credit. Annual pay credit = $5,000, annuity equivalent at age 65 = $152.69/mo. Immediate annuity=$23/mo (assuming 5% interest credits) Employee B age 55 employed as staff attorney earns $100,000 and participates in employer’s cash balance plan providing 5% pay credit. Annual pay credit = $5,000, annuity equivalent at age 65 = $57.55/mo. Immediate annuity= $29/mo (assuming 5% interest credits) Under this theory a few other well known defined benefit plan designs violate § 204(b)(1)(H).

    9. Contributory DB Plan Accrual Rates under Age Discrimination Test in Cooper

    10. Variable Annuity Plan Accrual Rates under Age Discrimination Test in Cooper

    11. Indexed Career Average Pay Plan Accrual Rates under Age Discrimination Test in Cooper

    12. Indexed Final Average Pay Plan Accrual Rates under Age Discrimination Test in Cooper

    13. Social Security Old-Age Benefits Accrual Rates under Age Discrimination Test in Cooper

    14. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK Is The Essential Premise False? Treas. Reg. 1.411(a)-7(a)(1) Says “If the plan does not provide an accrued benefit in the form [of an annual benefit commencing at normal retirement age], the accrued benefit is an annual benefit commencing at normal retirement age which is the actuarial equivalent (determined under § 411(c)(3) . . .) of the accrued benefit determined under the plan.” ERISA § 411(c)(3) says the “actuarial equivalent” of an accrued benefit expressed as an account balance is determined by projecting forward at the “safe harbor” Code section 417(e)(3) rate, not the plan rate. Hence no whipsaw. Alternative Strategy: Reduce normal retirement age? PWC/Bank of America cases.

    15. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK ERISA § 204(b)(1)(H) is “the rate of benefit accrual reduced because of the attainment of any age?” Cash balance plans don’t reduce pay credits or interest due to attainment of “any” age. Legislative intent was to prohibit cessation/reduction of accrual at normal retirement age. The rate of benefit accrual should be based on pay credits, not normal retirement annuity “equivalents.” Eaton v. Onan Corp; Tootle v. ARINC, Inc.; Godinez v. CBS Corp.; Campbell v. Bank Boston (dicta); Register v. PNC Financial; Proposed IRS Regs.

    16. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK New “disparate impact” theory under the Age Discrimination In Employment Act Conversions have a greater impact on older employees because of “wear-away”. Specific intent to discriminate need not be established. Defenses Plan design decisions are based on “reasonable factors other than age”, such as increased employee mobility, cost, business needs. Statute of limitations.

    17. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK § 204(h) Claims Plaintiffs’ Theory: Cash balance conversions reduce “the rate of future benefit accrual” triggering 204(h) notice requirements. Register v. PNC Financial This gives Plaintiffs a lot to complain about since 204(h) notice requirements are specific and subjective. Timing requirements Content requirements Recipient requirements Egregious failures require ignoring the amendment.

    18. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK Partial Termination Claims Plaintiffs’ Theory: Cash balance plan conversions are a partial termination of the plan because they reduce future benefit accruals and create or increase the potential for a reversion Treas. Reg. 1.411(d)-2(b)(2); Cooper v. IBM Pension Plan Failure to fully vest all affected participants violates ERISA section 204. Issues Is the rate of future accrual actually reduced? Is the prospect of a reversion increased?

    19. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK The Plaintiffs’ Anti-Backloading Theory “Wear-away” violates the 133 1/3% rule because, after it stops, benefit accruals increase by infinity. The problem with this theory: ERISA § 204(b)(1)(B)(I) – the cash balance conversion amendment is treated as in effect for all prior years. The “grandfathered” benefits are disregarded so there is no “wear-away”. Employees continue to accrue “grandfathered” benefits by growing into early retirement subsidies.

    20. NEW (UNPUBLISHED) IRS ANTI-BACKLOADING INTERPRETATION Example: D.B. Plan provides the greater of 10% FAE or 1% FAE per year of service

    21. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK The Solution? Treasury Regulations Clarifying That The Principal Difference Between DC And DB Plans Is Not A Normal Retirement Annuity, It Is Who Bears the Investment Risk. Will It Come? Not Anytime Soon. Treasury withdrew age regulations. Declined to issue whipsaw regulations. Punting to Congress. Regulation by litigation.

    22. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK AN UNINTENDED AND UGLY BIPRODUCT OF CASH BALANCE LITIGATION -- MORTALITY DISCOUNTS In determining D.B. lump sums, actuaries “discount” for the probability of preretirement death because the “accrued benefit” is forfeited on death. Xerox: Judge Posner held that preretirement mortality discounts could not be applied in determining cash balance plan lump sums because the hypothetical account is paid to the survivor. See also Crosby v. Bowater Retirement Plan, etc. But see Lyons v. Georgia Pacific, holding that mortality discounts are legal if provided for in the plan.

    23. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK LITIGATION OVER MORTALITY DISCOUNTS All defined benefit plans pay death benefits (they are required to) and most pay lump sums of at least $5,000. If Posner is right, all D.B. plans have underpaid lump sums. Why he’s wrong: Treas. Reg. 1.411(a) – 7(a)(1): the “accrued benefit” does not include “incidental death benefits.” Incidental death benefits are defined by IRS as having a value less than 25% of the accrued benefit.

    24. CASH BALANCE/DEFINED BENEFIT PLANS UNDER ATTACK Why Judge Posner is wrong (cont’d): Under standard mortality tables, cash balance plan death benefits (the entire hypothetical account) have an actuarial value of less than 25% of the accrued benefit. Therefore, typical cash balance plan death benefits are “incidental” and not part of the “accrued benefit,” which disappears on death, and preretirement mortality discounts are appropriate. If they aren’t, the D.B. system is in even more trouble.

    25. NEW (UNPUBLISHED) IRS ANTI-BACKLOADING INTERPRETATION Alternative benefit formulas must be combined to determine compliance with backloading rules even if the formulas individually satisfy the rules. Results: Outlaws many preexisting defined benefit plan designs Outlaws frontloading Exposes defined benefit plans to more litigation Creates further disincentives to establish D.B. plans

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