AARP Hearing Center
Background
Pension experts are exploring the potential for hybrid retirement plans. These plans would combine features of defined benefit (DB) and defined contribution (DC) plans to better distribute investment, interest, and longevity risks between the plan sponsor and the participant. One such hybrid plan is a cash balance plan under which employers credit a participant's account with a set percentage of their yearly compensation. In some cases, employees also contribute. The account grows by a pre-set percentage each year. On retirement, the account can be taken as either a lump sum or as an annuity, sometimes based on a set formula. Unlike a 401(k) plan, investments are managed collectively, and benefits are not tied to the performance of the plan’s portfolio.
The conversion of a traditional defined benefit plan to a cash balance plan can negatively affect older workers. Traditional DB plans often base the benefit calculation on the salary in the worker’s final years. These years are generally those with the highest earnings. In contrast, benefits in a cash balance plan are based on all working years, including early years when the worker’s salary was lower. As a result, older, longer-serving employees may work for many years after a plan conversion without receiving additional pension credits under the new cash balance plan. This effect is often called wear-away.
Certain corporate pension plans, including some that are frozen, have become overfunded due to higher interest rates and strong stock returns. As a result, some corporations have decided to reopen these old pension plans. Unfortunately, instead of reinstating the former benefit formulas, they have created new, less generous pension benefits designed solely to save the company money.
HYBRID RETIREMENT PLANS: Policy
HYBRID RETIREMENT PLANS: Policy
Protections
Policymakers should ensure that cash balance and other hybrid plans do not discriminate against older workers and that they maintain the important benefit protections of defined benefit (DB) plans.
Any change from a 401(k) match plan to a pension plan, whether new or reopened, should at least provide employees equivalent benefits in the short and long term.
Congress should require that in any type of conversion, employers provide each affected individual with a personalized benefits statement, with a comparison of the benefits under the old and new plans. The benefits statement should be provided well in advance of the effective date of the conversion. This should be done both when a plan is converted from a DB plan to a cash balance plan or where a previously closed or frozen DB plan replaces a defined contribution plan.