Revisiting the Hybrid Option

Smaller employers appear to be embracing cash-balance plans at a double-digit rate. Large employers, however, are another story, though some experts suggest greater regulatory clarity could spur more to add the option going forward.

Thursday, August 2, 2012
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Alan Glickstein, a senior retirement consultant with Towers Watson in Dallas, is in the curious position of being a retirement consultant whose cash-balance plan is one of the few investments he has that's risen in value over the past few years.

Glickstein's account was opened through Kwasha Lipton but, because the firm doesn't exist in that form anymore, the pension is being maintained by a successor organization.  

At a time when short-term interest rates are close to zero, Glicksteins's cash-balance account offers him professional management and a company-guaranteed return, which, in his case, means the account value has risen between 5 percent and 6 percent a year over the last decade.

Clearly, those who have been in the retirement business long enough to remember the cash-balance related lawsuits and legislative battles of the past -- illustrated most poignantly, perhaps, by the group of IBMers who took their battle to public when many older, longer-term employees were due to lose valuable perks during IBM's cash-balance conversion in 1999. (Ultimately, IBM gave more of its employees the option to opt out of the new plan, but it was an ugly battle, one that may still have plan sponsors recoiling as they consider implementing one of these plans for their workers today.)

Yet, much has changed from a regulatory perspective during the past few years, making it easier to credit interest to cash-balance accounts. Glickstein believes that, for some HR directors and retirement-plan officials, the cash-balance plan can be a useful tool -- one that will engage some employees in the retirement process due to its visible account balances -- and one that could serve the needs of plan participants who've become increasingly interested in gaining security and peace of mind after the stock market meltdown eliminated many of their 401(k) account proceeds and dashed many of their dreams for the future.

In determining the popularity of cash-balance plans today, it's useful to look at the statistics, which point to some real growth in the cash balance approach among small companies with less than 100 employees, but stalled progress for just about everyone else.

A recent report by Dan Kravitz, a plan-design expert and administrator with Kravitz Inc. in Los Angeles, examined Form 5500 filings and found a 21-percent annual increase in new cash-balance plans created between 2009 and 2010.

But the report also revealed that 84 percent of all cash-balance plans in place today are for employers with 100 employees or less and 46 percent of cash-balance-plan recipients are at firms with 10 employees or fewer.

At firms of all shapes and sizes, the prevalence of cash-balance plans is much smaller. The 2012 Employee Benefits Report released by the Society for Human Resource Management in June found that just 6 percent of employers represented in SHRM's survey offered cash-balance plans in 2012, down from 8 percent in 2011 and 9 percent in 2010.

 "Overall, defined-contribution-retirement plans (92 percent) were the most common type of plan offered, followed by Roth 401(k) savings plans (34 percent), traditional defined-benefit pension plans (21 percent) and cash-balance pension plans (6 percent)," the report says. "In addition, 7 percent offered supplemental executive-retirement plans."

None of the SHRM respondents planned to offer cash-balance plans during the next 12 months.

It's important to note that SHRM's report covers employers both large and small, with 35 percent of the organizations it polled having 100 to 499 employees and another 35 percent having between one and 99 employees. The balance of those polled -- 29 percent -- had more than 500 employees, and, in some cases, more than 2,500. Moreover, Towers Watson has been following the progression of cash-balance plans for the past 12 years, and has determined that most large employers with thousands of employees -- and sometimes, tens of thousands -- have been moving quickly toward a defined-contribution formula.

Clearly, at larger firms, cash-balance plans have been diminishing over the past several years. Among the 424 companies Towers Perrin, (now Towers Watson), looked at in 2000, 296 were offering traditional defined-benefit plans, 97 offered hybrid plans with DC features (including cash-balance programs) and 31 offered DC plans only.

By 2012, everything had "flipped completely," says Glickstein, who worked at Kwasha Lipton when it developed the first-ever cash-balance plan for Bank of America in 1985. Those with 401(k)s or DC plans only had risen to 272; those with hybrids, including cash-balance plans, had dwindled to just 82 plans in total, though they still outnumber the 70 that provide traditional pension plans.

So what's going on here?

"Anecdotally, I know many large employers looking at plan design eight to 10 years ago felt cash-balance plans were not a viable option as the result of court cases and regulatory uncertainty," says Glickstein.

Regulatory changes since then make cash-balance plans less risky, however, and that could herald another shift back towards these plans.

"Although cash-balance plans account for a large percentage of defined-benefit-retirement plans covering new hires, the number of new cash-balance plans had slowed to a trickle since the passage of the Pension Protection Act in 2006, largely because of the absence of clear regulations," SHRM reported early last year.

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"While awaiting guidance, employers that wanted to move to an account-based or capital-accumulation plan, but were concerned about the negative financial aspects of traditional DB plans -- most notably cost level and cost volatility -- had only one practical option: a traditional defined-contribution plan, such as a section 401(k) plan or profit-sharing plan.

"In late 2010," the report says, "employers received much of the clarity they were waiting for about the design and structure of cash-balance plans when the Internal Revenue Service issued proposed and final regulations."

Specifically, one section of the PPA, for the first time, made clear that cash-balance plans -- while not necessarily as benefits-rich for older, longer-term workers as compared to many traditional pension plans -- are legal and not age-discriminatory, Glickstein says.

Also, as Kravitz' cash-balance report explains, 2010 IRS Cash Balance regulations clarified and expanded employer options for "interest crediting" on cash-balance contributions for plan participants.

Why is it, then, that small employers are the ones that remain most enamored of these plans? Much of it comes down to their need for a tax-deferred savings shelter, and the cost efficiencies associated with spreading retirement contributions across a small group of workers as opposed to thousands of employees.

At an organization with only 50 employees in total, Kravitz explains, it often makes sense for owners who are required to make contributions on behalf of all employees to contribute to a cash-balance plan. This will allow them to both reduce taxable income and utilize profits as plan contributions that can benefit all workers; and increase their retirement savings beyond the amounts a 401(k) or 401(k)/profit-sharing plan will permit.

As always, employers may be able to attract employees with a cash-balance approach, given the fact that benefits which can be viewed in the form of easily understood account balances and these account balances can usually be taken as a lump sum at retirement, rather than as an annuity stream over the course of many years.

And with the regulatory relief that's been given to date -- with still more clarification anticipated shortly -- the deciding consideration for HR executives and pensions officers at companies both large and small may come down to whether employers are willing and able to guarantee a specified retirement benefit at this point in time, says Glickstein.

As with any DB plan, cash-balance plan participants cannot lose their money.

"The investment risk is on the employer," he says, and these days, participants are likely to appreciate it.

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