In february, suntrust Banks announced that it wouldfreeze its $2.2 billion defined ben-efit pension plan effective January1, 2008, for employees with fewer than 20 years of service. Like many U.S. corporations, SunTrust is softening theblow by sweetening its 401(k) plan. But theAtlanta-based bank is going one step further, replacing its soon-to-be-frozen pension witha cash balance plan that enables employees to continue earning a fixed benefit funded by the bank and take it with them as alump-sum distribution if they choose toleave before they reach retirement age.We like the balance of the defined benefit and the defined contribution plan, says SunTrust director of benefits Donna Lange.
The shift from traditional pensions to cashbalance and other types of hybrid plans began more than a decade ago. But in 2003, when about one quarter of large companies were offering such plans, the momentum halted abruptly after afederal court held that IBM Corp.s cash balance plan discriminated against older employees. More recently, two major developmentshave encouraged corporations to take a sec-ond look at cash balance arrangements. Last August, Congress passed the Pension Protection Act of 2006, which clarified rules on age discrimination and other key provisions. And both an appellate court and the U.S. Supreme Court upheld IBMs plan, reversing the lower court decision.
Now, says Stewart Lawrence, head of the retirement practice at benefits consulting firm Segal Co., practically all ofour clients are considering cash balance plans. In addition to SunTrust, packaging products manufacturer Mead-Westvaco Corp., package delivery company FedExCorp. and insurer Phoenix Cos. have announced that they will replace their traditional pension plans with cash balance or other hybrid plans and many consultants expect a flurry of conversions this fall, the traditional season for benefits changes. Some industry observers predict that within five years as many as one third to half of large corporate employers will offer hybrid plans.
Plan sponsors making the transition face challenges, of course. Even though the legal status of cash balance offerings has been clarified, older workers, those who retire before age 65 and those whose pay is rising rapidly generally do worse than they would in a traditional defined benefit pension. Thats because traditional pensions tend to reward late-career pay and may also provide early-retirement incentives. As a result, says Segals Lawrence, when an employer makes the switch, there is a perceived feeling [among employees] that I signed on withone deal, and now youre changing the deal on me.
Companies converting to a cash balance plan almost always take steps to ease the tran-sition. Employers may grantextra credits for older workers or improve other benefits. They may also make the switch optional for certain categories of workers. Thats what SunTrust is doing for employees with at least 20 years of service. Still, those who stay in the legacy pension plan will earn benefits at a reduced rate. In contrast, employees who switch to the cash balance plan will be able to add overtime, commissions and bonuses to the definition of base pay used to calculate payouts.
Mead Westvaco is also using a flexible approach. At the Richmond, Virginiabased company, workers 40 or older can switch tothe cash balance plan or continue accruing pension benefits, which wont be reduced.
Alison Borland, a senior benefits consultant in the retirement practice of Hewitt Associates, says that giving employees such choices works only if the two plans are close enough in value. Otherwise, she warns, offering a choice simply becomes an administrative expense for the plan sponsor, as employees are apt to stick with their existing defined benefit option. To avoid that outcome, many companies provide the cash balance plan only to new recruits and keep existing employees in the old plan regardless of their age or years of service.
Another option is to simply give olderworkers a better payout. Thats the approachat Memphis, Tennesseebased FedEx, whose voluntary cash balance plan, launched in 2003, will become mandatory next June. In a standard cash balance plan, every eligible employee is allocated a fixed percentage of salary each year usually 5 to 6 percent plus an interest credit pegged to Treasury billrates. But at FedEx the salary percentage rises with age and years of service, up to 8 percentof pay and workers over 40 can get asmuch as 5 percent on top of that amount.
Depending on the incentives andenhancements to other benefits, a cash bal-ance plan may not end up costing any lessthan the defined benefit plan it is replacing. Nonetheless, the costs are typically more stable. For benefits managers and their colleagues in the finance department, thatmakes all the difference in the world.