The Treasury Department's view, announced last week, that "cash balance" pensions do not violate federal age discrimination laws may open the floodgates to these hybrid plans.
Employer groups applauded cautiously, noting that other uncertainties remain for companies seeking to convert their traditional pensions. But it seems likely that conversions, which were on the rise until a Clinton administration moratorium in 1999, will resume when the Treasury's new regulations become final. That is expected next year.
This is a controversy that every worker should pay attention to. Pension benefits almost always depend heavily on the passage of time, and decisions that workers make in their youth -- or that employers make for them when they're in mid-career -- can have an enormous impact on retirement income.
There may not be much that workers can do if their employer decides to convert. The Treasury has deemed such shifts legal, if employers follow the new rules. But some companies do listen to worker protests, and they may sweeten the pot if there's an outcry. Plus, understanding your benefits, or lack of them, will help in weighing other firms' job offers.
Younger workers should ask themselves one key question when considering where to work: Which plan better fits your expected career?
The question arises because while both traditional pensions and cash-balance plans are "defined benefit" plans, they distribute benefits quite differently.
Under a traditional pension, benefits typically are a percentage of a worker's earnings, usually in his or her highest-pay years, multiplied by the number of years of employment at the company.
The percentage is usually 1 to 2 percent. At 1 percent, a worker with 30 years of service would get a pension equal to 30 percent of average pay for the highest-paying few years -- usually three or five -- of service. So a worker whose highest three years of pay averaged $60,000 would receive an annual pension of $18,000.
There are other formulas, but this one, called a "final average" type, is common. Its key characteristic is that benefits accumulate more rapidly later in a worker's career. As time passes, the benefit formula causes one larger amount (pay that presumably rises over time) to be multiplied by another rising amount (years worked), so that if you plot the benefits on a graph, the curve slopes upward much more steeply in later years.
If you figure to spend many years with a company and end up with fairly high pay, this kind of plan can reward you with a generous pension.
Cash-balance plans, by contrast, cause benefits to accumulate in a much more linear manner.
With these plans, the employer creates a hypothetical account for each worker and credits to this account a percentage of pay each year, plus interest on the account's balance. These "pay credits" and "interest credits" accumulate as long as the worker remains with the company. Workers who quit can take the account balance as a lump sum and roll it over into an individual retirement account, where it can continue to grow. Workers who remain at the company until retirement can take the lump sum or, in most plans, turn it into an annuity.
Younger workers who expect to job-hop throughout their careers are likely to find cash-balance pensions advantageous.
So neither plan is inherently good or bad. Each has advantages and disadvantages for different sets of workers.
The controversy over conversions involves the treatment of older workers and overall reductions in their benefits.
Workers who are at mid-career with a company that has a generous traditional pension typically count on that pension in their retirement planning. When it is suddenly converted to a cash-balance plan, they can see their pension shrivel. Some companies protect older workers -- for example, by allowing them to remain in the old plan -- but not all do, and even at firms that "grandfather" some workers, others inevitably miss the cutoff and are outraged.
Those planning to stay at such a company for years quickly realize that if the new plan provides better benefits for shorter-term workers, it must provide less for the longer-term ones unless the employer is prepared to put more into the plan -- and few do that.
The result has been an explosion of litigation, much of it charging age discrimination. While a court could still decide that the Treasury is wrong, the agency's position in the new regulations will make those cases much harder to win.
"What the Treasury did was, they took us off at the knees," said Kathi Cooper, the lead plaintiff in a class-action suit against IBM that accuses the computer giant of age discrimination in shifting to a cash-balance pension plan.
The new rules do provide some protections for benefits earned under the old plan when a company converts, but there can still be circumstances under which older workers might find themselves earning no new benefits for years after the conversion.
J. Mark Iwry, the former benefits tax counsel at the Treasury, said that cash-balance plans have "meaningful long-term virtues," in particular their improvement of benefits for workers who change jobs frequently. But, he said, "in the short term, the conversion to a cash-balance plan is tantamount to a pension pay cut for older workers unless they are protected."
"The proposed regulation could be viewed as a first step, but older workers need more protection in conversions, and Congress could step up and provide it without killing cash-balance plans," Iwry said.
Other experts also expressed concern that the new rules could make it quite difficult for companies to design plans that split the difference, improving benefits for younger workers without penalizing older ones so heavily.
"We are okay on very front-loaded approaches and on very back-loaded approaches . . . but you can't do anything in the middle," said Eric Lofgren of benefits consultancy Watson Wyatt Worldwide.
The number of taxpayers paying the alternative minimum tax grew 28.1 percent in 2000, to more than 1.3 million, the Internal Revenue Service said last week. At the same time, the amount owed by taxpayers under the AMT grew even faster, jumping 48.2 percent from the 1999 level, to $9.6 billion.
In other just-released data from 2000, the year that marked the end of the boom, tax collections were still rising. Individual adjusted gross income surged 8.7 percent, to almost $6.4 trillion, and income taxes paid by individuals grew at an even faster pace, to nearly $981 billion.