8 - Cash Balance and Other Hybrid Retirement Plan Approaches

Question 1

retirement plans that blend attributes of traditional defined benefit pension plans and traditional defined contribution plans. Are implemented by plan sponsors in an effort to meet plan objectives that these plan sponsors find difficult to achieve with either traditional defined benefit or traditional defined contribution plans, alone or in pairs.

Answer 1

Hybrid retirement plans

Question 2

While hybrid plans come in several types and plan designs, each is considered either a defined benefit or a defined contribution plan for the purposes of ___________.

Answer 2

tax qualification

Question 3

Among factors that should be considered in designing a hybrid retirement plan are:

1. _________ and mobility
2. __________ toward current retirement benefits
3. Relative levels of ______ and rates of benefit _____
4. _______ for the plan sponsor
5. Certain other items, such as awareness of the ______, regulatory and public relations environment of hybrid plans. These are especially important since plan sponsors have been criticized for the negative effects of benefit accruals or values for certain groups of plan participants upon conversion to a hybrid plan. This criticism of plan sponsors has at times resulted in _____.

Answer 3

1. Workforce demographics
2. Employee attitudes
3. benefits / accrual
4. Cost constraints
5. legal / costly litigation

Question 4

Defined benefit hybrid retirement plans possess certain features that are characteristic of traditional defined benefit plans. These plans promise a specific _________ for participants and plan sponsors manage the investing of plan assets through commingled funds.

Hence, the ____ sponsor bears the investment risk and reaps the benefit of investment rewards. Defined benefit hybrid plan structures make it relatively easy for plan sponsors to integrate the plan with Social Security and target income replacement ratios. These plans offer distributions in the form of annuities and are subject to Employee Retirement Income Security Act (ERISA) requirements such as minimum standards for eligibility, vesting and funding. Annual actuarial _______ are required, as is payment of plan termination insurance premiums to the Pension Benefit Guaranty Corporation (PBGC).

Answer 4

benefit level

plan

valuations

Question 5

Defined benefit hybrid plans also possess certain features that are characteristic of traditional defined contribution plans. In addition to allowing for distribution of benefits in an annuity form, defined benefit hybrid plans also offer _____ as a distribution option. This feature which makes for portability and benefits expressed in terms of lump- sum values typically makes these hybrids of greater appeal to _______ and more mobile workers.

Answer 5

lump sums

younger

Question 6

A cash balance plan is a defined benefit hybrid retirement plan where the sponsor typically makes plan contributions based on a specified formula that provides an annual ________ and applies a fixed interest rate credit. Although this is the typical cash balance design, there can be variations on this benefit design. Some variations include:

• (1) Linking benefits to an ________ rather than a fixed rate of return, or
• (2) A lower level of guaranteed benefits but ______ elements allowing for increased contributions in periods of superior business performance.

Answer 6

contribution credit

equities index

profit-sharing

Question 7

Cash balance plans do not involve ________ investments by plan participants in individually allocated accounts. However, cash balance plans take on the appearance of individually allocated defined contribution accounts since plan participants receive periodic ________ based on hypothetical accounts showing accrued benefit balances. These are merely a ________, however, since in actuality plan assets are commingled and their investment is directed by the plan sponsor. The amount of benefit shown on the account statement bears no relationship to actual assets held by the plan.

Answer 7

self-directed

benefits statements

communication tool

Question 8

Plan sponsors may benefit from conversion of a traditional defined benefit plan to a cash balance plan because, as career average plans, they are likely to be less ______ than a final pay defined benefit plan. Additionally, the plan sponsor of a cash balance plan may guarantee an interest rate below what the sponsor expects it can generate on actual plan investments, and the higher rate of return reduces the future plan costs for the sponsor. (This difference is sometimes referred to as the investment _______.)

Answer 8

expensive

differential

Question 9

Pension equity plans are a type of defined ______ hybrid retirement plan where benefits are based on _________ and the _________ that participants receive each year while they are plan participants.

Upon termination of employment or retirement, the sum of percentage credits is applied to final average pay to determine the ______, which is portable.

The percentages upon which credits are based can be relatively flat, but often increase in steps with age or length of service. Although the benefits earned under a pension equity plan are expressed as a lump sum, participants must have the option to receive these benefits in the form of an _______ distribution. The age- or service-weighted credits and final average pay formula make pension equity plans appealing to older workers and persons hired in midcareer who have fewer years to accrue benefits.

Answer 9

benefit

final average pay

percentage credits

lump-sum benefit

annuity

Question 10

Compared with the traditional defined benefit plans that cash balance plans often replace, more benefit accrual typically takes place in __________ of service for participants of cash balance plans.

Answer 10

earlier years

Question 11

Combining earlier benefit accrual with portability makes cash balance plans more favorable to ______, more ______ workers. Conversion to a cash balance plan from a traditional defined benefit plan could negatively affect the benefits of midcareer or older workers who had begun to accrue sizable benefits in a traditional defined benefit plan.

Provisions enacted into law as part of the _________ have mitigated some of these adverse consequences related to conversion to a cash balance plan from a traditional defined benefit plan.

Answer 11

younger

mobile

PPA 2006

Question 12

How do benefits accrue in a pension equity plan as compared to a cash balance plan and traditional defined benefit plan?

• pension equity: benefits build steadily, but in steps, as credit percentages increase as participants move from one _______ to the next. The age- weighted brackets of pension equity plans often increase the rate of accrual with _____.

Answer 12

age bracket

age

Question 13

Benefit portability and the availability of lump-sum distributions are key features offered by many defined benefit hybrid retirement plans.

Advantages to Employer:

1. It may be easier to attract and retain younger and more mobile employees who would not normally expect to receive a significant benefit from _______ benefit plans.
2. Midcareer employees who are only remaining with the employer because of pension benefits can take their ________ and move their careers in a new direction. Companies find this to be beneficial since employees who are unhappy are able to leave and be replaced by more highly motivated employees.

Answer 13

traditional defined

account balances

Question 14

Benefit portability and the availability of lump-sum distributions are key features offered by many defined benefit hybrid retirement plans.

DISadvantages to Employer:

• (1) Portable account balances may make it too easy for employees to __________.
• (2) If benefits do not accrue quickly enough, younger and more mobile participants may not perceive ________ in the retirement plan.
• (3) If the overriding purpose of the plan is to provide retirement benefits, then the option to take a _______ upon retirement or termination of employment may defeat the plan’s primary purpose.

Answer 14

leave for other employment too quickly

sufficient value

lump-sum distribution

Question 15

Must defined benefit hybrid plans place investment decisions and the resulting risk and reward solely with plan sponsors?

Answer 15

NO

Question 16

There are certain issues that a plan sponsor should address in converting a traditional defined benefit plan into a hybrid defined benefit plan. Plan conversions often involve sensitive issues. Since different plans have different rates of accrual or allocation methods, some plan participants will fare better than in the previously offered plan and other plan participants will see a less favorable situation with the new plan. Employers need to consider:

• (a) The _______ of plan changes on participants
• (b) Since many plan participants may not be able to determine the impact of plan changes on themselves without assistance from the employer, plan sponsors should consider how to best communicate these impacts and _______ plan participants on the specific relevance of plan changes.
• (c) Regardless of the impact of these changes, employee _______ toward change and feelings about employer motives are important considerations. Failure on the part of a plan sponsor to adequately plan for and address these issues can result in detrimental effects to workforce _____, productivity loss, as well as costly litigation.

Answer 16

impact

educate

attitudes

morale

Question 17

“Pension wear away” is a term used to describe a condition occurring when a traditional defined benefit plan is converted to a _____ plan. This condition occurs for participants with _________ because of the difference in ________ between the two different types of plans.

Answer 17

cash balance

longer service records

benefit accrual patterns

Question 18

In converting from a traditional defined benefit to a hybrid defined benefit plan, are there approaches that companies can use to allow employees to avoid the adverse effects of plan conversion? Yes/No?

Some of these approaches would include the following:

1. Allowing all employees to choose between __________
2. Allowing employees whose benefits are adversely affected by the conversion the choice to ___________
3. Making an adjustment to initial _________ of the new plan for adversely affected employees
4. Making additional _______ to other plans sponsored by the employer and within which the adversely affected employees are participating.

Answer 18

• YES!

1. the old plan and the new plan
2. remain in the old plan
3. account balances
4. contributions

Question 19

Describe two key events that have occurred and their implication in quelling the controversy that has accompanied plan conversions from traditional defined benefit plans to hybrid retirement plans.

Answer 19

passage of PPA

Cooper v. IBM

Question 20

Under a target benefit plan, a plan sponsor’s required contributions are determined ________ in order to meet income replacement targets established in the plan at inception which are expressed in terms of a __________ near the time of retirement. Once an initial contribution formula is established, subsequent adjustments to actuarial assumptions are not made.

Answer 20

actuarially

percentage of salary

Question 21

Age-weighted profit-sharing plans use a ______ profit-sharing plan structure as their base plan for plan qualification purposes. The distinguishing characteristic with an age-weighted profit-sharing plan is that age factors are used to allocate contributions more heavily to _______, much like traditional defined benefit plan benefits favor workers with more years of service who are typically older participants.

Age-weighted plans tend to appeal to _______ with older executive staff and younger rank-and-file employees. Use of an age- weighted profit-sharing plan should be carefully considered. These plans do have certain drawbacks. For instance, two participants with the same years of service and pay levels could receive different annual allocations to their accounts because they fall within different __________, creating potential for dissatisfaction and misunderstanding among some participants.

Answer 21

traditional

older participants

smaller employers

age categories

Question 22

New comparability plans are a set of plan types that are similar to age-weighted profit-sharing plans. However, these plans take a further step when directing plan allocations by dividing participants into separate ________ groups (or rate groups) to provide larger percentage contributions to select participants.

Plan sponsors have wide latitude in the _____ used to establish the groups, such as job descriptions, ownership interest, age and length of service. Furthermore, plan sponsors have flexibility in determining how the allocation process will work under these plans.

Answer 22

allocation

criteria

Question 23

Certain elements of nondiscrimination testing are made more complicated when a plan sponsor offers an age-weighted profit-sharing plan or new comparability plan. Both age- weighted and new comparability plans must satisfy the requirements of IRC Section _____ that benefits not discriminate in favor of highly compensated employees.

These types of plans satisfy the nondiscrimination requirements using a process called _______. This is sometimes referred to as benefits testing because nondiscrimination is tested on the basis of _______ rather than on the basis of current contributions. It makes it possible to allocate more to __________ and older participants because, when compound interest assumptions are used to project benefits, lesser amounts of annual contribution are needed to provide younger and lower-paid participants with a projected benefit that is a substantial percentage of pay.

Answer 23

• 401(a)(4)
• cross-testing
• projected benefits
• highly compensated

Question 24

The _________ plan differs from other hybrids because it is actually two separate plans, a defined benefit plan and a defined contribution plan, working to complement one another.

Answer 24

floor-offset

Question 25

The interaction of two plans under a floor-offset plan is important. If the floor benefit guaranteed by the defined benefit plan is not high enough, it may encourage ________ investment behavior by participants. On the other hand, a reasonable floor may help encourage some _______ participant investors to accept more of the risk required to generate the returns necessary for retirement security.

Answer 25

excessively risky

risk-averse