3723 / What requirements must a cash balance plan meet in order to avoid discriminating based on age under the Pension Protection Act of 2006?

The Pension Protection Act of 2006 ended a long period of uncertainty for cash balance plans by amending the IRC, ERISA, and the Age Discrimination in Employment Act of 1967. The effect of the legislative changes provides that cash balance plans will not be age discriminatory if certain requirements are met.

A preexisting IRC requirement under which cash balance plans had been attacked stated that an employee’s benefit accruals may not cease, and the rate accrual may not be reduced, because of the attainment of any age.¹ Three parallel amendments provide that a plan will not be treated as failing this requirement if a participant’s accrued benefit, determined as of any date under the terms of the plan, would be equal to or greater than that of any similarly situated, younger individual who is or could be a participant.² Except as otherwise indicated below, the provisions of PPA 2006 applicable to cash balance plans are effective for periods after June 28, 2005.³

A participant is “similarly situated” if he or she is identical to another individual in every respect except for age; in other words, in circumstances such as period of service, compensation, date of hire, work history.⁴

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Planning Point: When modifying a pension plan to become a cash balance plan, even if all the assumptions may be reasonable, the communications to the participants are extremely important and care should be taken with their preparation to accurately state the impact of the changes on those participants. Communications must not be in any respect misleading or, of course, false.⁵

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“Accrued benefit” is defined by the plan terms; it may be expressed as an annuity payable at normal retirement age, the balance of the participant’s cash balance plan account, or some other means. Early retirement subsidies, permitted disparity, and certain other plan features are disregarded for this purpose.⁶

Prior to the passage of the PPA, the Seventh Circuit Court of Appeals held that a cash balance plan formula that was age neutral did not give rise to age discrimination under ERISA, and that an employer’s choice to convert from a defined benefit plan (which tends to favor older employees) to a cash balance plan (which does not) is not per se age discrimination.⁷