Cash Balance Plan - Conversion Controversy

Conversion Controversy

Cash balance conversions have been controversial and have raised the ire of workers and their advocates. In 2005 the Government Accountability Office (GAO) released a report analyzing the effects of cash balance conversions on worker benefits. They found that in a typical conversion the cash balance plan would provide lower benefits for most workers than if the defined benefit plan had remained unchanged and the worker had stayed in their job until retirement age. This decline in benefits tends to be largest for older workers. This is because in a traditional plan, where benefits are based on final average pay, the "value" of the benefits accrues much faster for older workers than for younger workers. In contrast, in a DC or cash balance plan, contributions are made at the same rate (by workers in the DC plans and by the employer in the cash balance plan), and a dollar contributed to a younger worker's account is actually more valuable because it has more time to compound before retirement. Thus some argue that cash balance plans hurt workers.

On the other hand, this may not be the relevant comparison. If the alternative to cash balance conversion is that the plan is frozen or terminated (with the vested balance going to the worker), all workers would be much worse off than in a cash balance conversion. This is a realistic possibility; tens of thousands of defined benefit plans have been frozen and/or terminated in the last two decades, far more than have been converted to cash balance plans. Likewise, for the many employees who leave their job before retirement (whether voluntarily or not), many would be better off under the cash balance conversion than under the original defined benefit plan. In addition, about half of cash balance conversions have grandfathered in some or all of the existing participants in the defined benefit plan.