What's Next for Cash Balance Plans?

What the Court Said

In Cooper v. The IBM Personal Pension Plan, a federal district court in southern Illinois ruled that IBM's pension equity and cash balance formulas violate the age-discrimination prohibitions of the Employee Retirement Income Security Act. ERISA prohibits defined-benefit plans from reducing a participant's accrued benefit when he or she reaches a certain age or length of service. It also prevents plan sponsors from reducing or terminating benefit accruals when a participant reaches a certain age.

IBM pension equity plan participants earn "points" in each year that they work; the number of points is based on their age in that year. The points are applied against earnings, and the resulting figure is divided by a "benefit conversion factor" to calculate the employee's annuity benefit at retirement. The court ruled that the plan is discriminatory because the benefit conversion factor increases with age. Thus, employees of different ages who work for the same number of years and earn the same salary accrue different retirement benefits. To illustrate this point, the court cited a hypothetical example of two employees whose ages differ by 15 years and who accumulate the same years of service at the same salary. The older employee's monthly retirement benefit would be about 13 percent lower than the younger employee's, the court said.

The court also noted that IBM's pension equity plan caps the number of credits an employee can earn. A participant who began working for the company at age 25 would stop earning points between ages 58 and 59, yet the benefit conversion factor would continue to increase. If this hypothetical individual continued working to normal retirement age, his or her accrued benefit would actually decline, according to the court.

IBM's cash balance plan also fails ERISA's age-discrimination tests, the court ruled. Plan participants earn monthly pay credits (5 percent of their salary) and interest credits based on Treasury bond yields. The interest credit rate is the same for all participants. However, at normal retirement age, a younger worker's credits will have accrued more interest than an older worker's. Thus the credits are inherently more valuable to younger than to older employees, according to the court.

IBM immediately announced that it will appeal. In a statement issued after the ruling, the company insisted that "IBM's plan always provides older employees with benefits of equal value or greater value than the benefits earned by younger employees. Neither the plaintiffs nor the judge ever disputed that fact. To call such a plan age-discriminatory makes no sense and ignores the fundamental principle of the time value of money."