Cash Balance Plan Ruled in Violation of
ADEA
M. Travis DeHaven, Edie Lindsay
Troutman Sanders LLP
Atlanta, Georgia
Cash balance plans are under attack - again. These defined benefit plans, which create a hypothetical account with hypothetical interest credits for each participant, have been litigated over and over again on a number of issues. A number of recent cases have focused on claims that these plans discriminate against older workers.[1] Although a variety of theories have been presented to support the age discrimination claim, the courts had, until recently, rejected these attempts. However, the recent decision by a U.S. District Court in Cooper v. The IBM Personal Pension Plan[2] took a contrary position and ruled that the cash balance plan at issue violated the age discrimination rules. The decision has precipitated reactions from the IRS and from Congress.
At least in part, the Cooper decision was made possible because the IRS has yet to publish final, definitive guidance on cash balance plans in general and the age discrimination issues in particular.[3] In December, 2002, the IRS proposed regulations which established standards for cash balance plans to avoid violating the age discrimination rules.[4] Briefly, those rules prohibit a pension plan from reducing the rate of benefit accruals because of age. Under traditional analysis, the rate of benefit accrual is measured by calculating the rate at which a participant’s normal retirement benefit (that is, the benefit projected to be paid at normal retirement age) increases each year. Under a cash balance plan, the rate of accruals does slow as a person ages[5], so this type of plan will violate the age discrimination rules if the only acceptable method of measuring the rate of increase is by looking at the growth in the projected normal retirement benefit. However, under most cash balance plans, the rate of benefit accrual will not discriminate on the basis of age if the rate of increase is measured by comparing the growth in the value of the benefit from one year to the next.
The IRS recognized in its proposed regulations that a cash balance plan could satisfy the age discrimination rules by valuing the rate of benefit accrual on a year-by-year basis, provided that the plan meets certain design criteria. However, the Cooper decision took no notice of the proposed regulations and essentially ruled that it was impossible for a cash balance plan to meet the requirements of the age discrimination rules.
In an analysis that seemed more motivated by outrage at the build up of surplus assets in the plan following its conversion to a cash balance design than by any serious consideration of the issues, the Cooper court ruled that a cash balance plan violated these provisions. The court dismissed IBM’s argument that the differences in benefit accruals reflected the time value of money rather than discrimination on the basis of age and ruled instead that benefit accruals impermissibly decreased as a result of the participant’s age.
The Cooper opinion did not discuss the decision in Eaton v. Onan[6], the only other published opinion that decides the issue.[7] The Eaton court considered the plaintiff’s age discrimination claim and determined that the cash balance plan at issue did not violate those rules. That court noted that the age discrimination provisions do not require benefit accruals to be measured solely in terms of the increase in the normal retirement benefit. The court evaluated the rate of benefit accruals on the basis of yearly increases, and ruled that there was no discrimination on the basis of increasing age.
The Eaton opinion was rendered prior to the publication by the IRS of its proposed regulations. These proposed regulations were published prior to the decision in Cooper, but they are not mentioned in the opinion and it is not clear whether they were raised before that court. However, the IRS has taken note of the Cooper decision and recently indicated that it was looking hard at age discrimination issues, acknowledging that any defined benefit plan that bases accruals on something other than the traditional final average earnings will have difficulty meeting the age discrimination requirements if the evaluation is based solely on the rate of increase in the normal retirement benefit. While the IRS has not indicated the position it will take in the final regulations, it seems committed to accommodating the special considerations inherent in the design of cash balance and similar plans.
Because of the conflict between the Cooper decision and the proposed regulations, it is important for the IRS to finalize the regulations and provide some stability in this area.
However, at the time of this writing, the House of Representatives had approved an amendment to the Treasury/Transportation appropriations bill (H.R. 2989) which would block the Treasury Department and the IRS from completing the regulations in a manner that would contradict the Cooper ruling pending any appeal of that case.
While we believe the Cooper decision was poorly reasoned, there is much popular sentiment against cash balance plans and sponsors of these plans will need to continue to tread carefully until these issues are resolved.
[1] See Campbell v. Bank Boston, N.A., 2003 WL 834720 (1st Cir. 2003); Eaton v. Onan, 2000 WL 1459801 (U.S. Dist. Ct. S.D. Ind. 2000).
[2] 2003 WL 21767853 (U.S.D.C. S.D. Ill. 2003).
[3] The prohibitions on age discrimination appear in substantially similar terms in the Internal Revenue Code, the Employee Retirement Income Security Act (ERISA) and the Age Discrimination in Employment Act (ADEA). The IRS has been delegated the authority to promulgate regulations interpreting all three statutes.
[4] REG-209500-86, including Prop. Regs. § 1.411(b)-2.
[5] This results from the application of other benefit accrual rules to cash balance plans. In most such plans, a participant is credited each year with a “compensation credit” based on some percentage of his compensation, and an “interest credit” based on a stated interest rate (or an index). To satisfy the rules related to “backloading” of pension accruals, cash balance plans are required to project the interest credit to the participant’s normal retirement age and accrue that projected value in the year in which the interest credit is earned. Since the time remaining until normal retirement age decreases each year as a participant ages, the value of the interest credit decreases each year (all other things being equal). Thus, the rate of benefit accruals decreases as the participant nears normal retirement age.
[6] 2000 WL 1459801 (U.S.D.C. So. Ind. 2000).
[7] In Campbell v. Bank Boston, N.A., 2003 WL 834720 (1st Cir. 2003), the court addressed these issues but did not decide them because they were not raised in the lower court.