Private Pensions

There has been recent controversy concerning how conversions of traditional defined benefit pension plans to cash balance plans can affect workers, especially those nearing retirement. Employer-provided pensions are an important source of income for many retired persons. To encourage employers to establish and maintain pension plans for their employees; the federal government provides special tax treatment under the Internal Revenue Code (IRC) for plans that meet certain requirements. GAO addressed several aspects which includes: (1) the prevalence and major features of cash balance plans, and reasons why firms adopt them; (2) how the use of cash balance plans affect the pension benefits for workers of different ages and tenure, particularly after conversion; and (3) what information employers converting to cash balance plans typically provide to plan participants and how disclosure might be improved. Firms in many sectors of the economy sponsor these plans but there is greater awareness found in the financial services, health care, and manufacturing industries. Cash balance plans provide a larger share of a participant's accumulated benefit earlier in a career, compared with a traditional defined benefit plan that is based on final average pay. As a result, conversions can increase the value of some workers' benefits, especially younger or short-tenured workers who leave firms before retirement. Unlike traditional defined benefit plans, cash balance plans can result in a declining rate of normal retirement benefit accrual over time.

GAO noted that: (1) GAO's survey of 1999 Fortune 1000 firms indicates that the number of firms sponsoring cash balance plans has increased within the last few years, with few firms sponsoring such plans prior to the early 1990s, but increasing to about 19 percent of all Fortune 1000 firms this year; (2) these plans cover an estimated 2.1 million workers; (3) firms in many sectors of the economy sponsor these plans but greater concentrations are found in the financial services, health care, and manufacturing industries; (4) about 90 percent of the firms GAO surveyed that sponsor such plans previously covered their workers under a traditional defined benefit plan; (5) most of the conversions occurred within the past 5 years; (6) key reasons firms gave for converting include lowering total pension costs, adding a lump sum feature to increase the portability of pension benefits, thereby improving the firm's ability to recruit more mobile workers, and facilitating communication of the value of plan benefits; (7) as with traditional pension plans, cash balance plan designs vary significantly; (8) conversions to cash balance plans can be advantageous to certain groups of workers, for example, to those who switch jobs frequently, but can lower pension benefits for others; (9) cash balance plans provide a larger share of a participant's accumulated benefit earlier in a career, compared with a traditional defined benefit plan that is based on final average pay; (10) as a result, conversions can increase the value of some workers' benefits, especially younger or short-tenured workers who leave firms before retirement; (11) unlike traditional defined benefit plans, cash balance plans can result in a declining rate of normal retirement benefit accrual over time; (12) this declining accrual rate can result in older workers receiving lower benefits at retirement from a cash balance plan than they would have from a traditional final average pay plan if it had not been converted; (13) current disclosure requirements provide minimum standards for the information plan sponsors must give participants about plan changes; (14) GAO found wide variation in the type and amounts of information workers receive; (15) the communications provided to employees vary from general statements about plan changes to specific examples of how a conversion to a cash plan might affect workers of different ages and tenure; and (16) often, sponsors did not ensure that participants received sufficient information about plan changes that can reduce future benefit accruals.

Recommendations

Our recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.

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