10th Circuit Puts Another Nail In The Coffin For Cash Balance Plan Litigation

It's been a roller coaster ride for cash balance plans during the past 20 years or so – first the darlings of the benefits world, then the devil incarnate. Now, are they again the savior of the defined benefit plan or have they been rendered largely irrelevant? And what of all of the frightful litigation – is it over, or are we still suffering through the agonies of these cases? On August 11, 2011, the Tenth Circuit issued its decision in Tomlinson v. El Paso Corporation, addressing most of the issues that remain and again finding in favor of the plan sponsor.1

What Is a Cash Balance Plan?

A cash balance plan is a defined benefit plan, which means that the benefit is defined pursuant to a formula, the employer contributes to a trust fund that is designed to accumulate sufficient funds to pay the promised benefits, and the participant receives the promised benefits regardless of the investment performance of the trust fund. The employer guarantees the trust fund's sufficiency, and, if the employer is unable to pay any trust fund shortfall, the federal Pension Benefit Guaranty Corporation guarantees the benefit up to a statutory maximum.2

In a traditional defined benefit plan, a participant's annual retirement benefit is based on a benefit factor (either a fixed dollar amount or a percentage of average or final average compensation) multiplied by the participant's years of service at retirement. In a cash balance plan, the participant's benefit is stated as a cash balance as of any given date, but the cash balance is a nominal bookkeeping account, rather than a separate account within the trust fund. El Paso's cash balance plan is typical – the cash balance includes:

An opening balance – usually the prior benefit converted to a lump sum value (in the case of a conversion from a traditional defined benefit plan)3 – newly hired employees start with zero; Annual "pay credits" equal to a percentage multiplied by the participant's earnings for the current year;4 "Interest credits" equal to the cash balance for the prior year, multiplied by an interest factor reflecting current interest rates. The participant's annual pension benefit is the actuarially-equivalent annuity that can be "purchased" by the cash balance. Unlike a defined contribution plan, however, the interest credited to the participant's cash balance is not subject to the risks of investment fluctuations. The employer guarantees the payment of accrued benefits just as the employer guarantees the benefits under any defined benefit plan. The cash balance plan works like a defined contribution plan where the employer guarantees the rate of return (with the Pension Benefit Guaranty Corporation acting as the back-up guarantor, just as in all other defined benefit plans).

Just as cash balance plans act like defined contribution plans with a guaranteed return, the benefit accrual pattern of a cash balance plan also acts like a defined contribution plan – the benefit accrues evenly throughout the employee's employment. Converted to an annuity at age 65, the annuity that can be purchased for a younger employee with a given contribution is much higher than the benefit that can be purchased for an older employee receiving the same contribution – primarily because the younger employee's "account" will have many more years to earn compound interest before being drawn down at retirement to fund the annuity. The El Paso plaintiffs argued that because the annuity was lower for an older employee than for a younger employee with the same salary and years of service, the accrued benefit violated the Age...