Beyond the 401(k)

A marketing book for cash balance plans that came out in 2010 geared for financial advisors with some questionable assertions* but also some helpful excerpts (some for my clients) including on pension history:

The partnership”s agreement must define the method of allocation among the partners. Most partnerships that adopt Cash Balance Plans don’t want the partners’ contributions allocated in the same manner as other firm expenses,m in proportion to earnings. (page 13)

As costs for employee medical benefits skyrocketed in the 1980s and 1990s, many business owners had to cut costs on the pension side. Many moved away from costlier, traditional defined benefit plans toward 401(k) plans which were less expensive to operate and allowed greater flexibility for employer contribution levels. This shift also removed the investment risk for employers. (page 23)

Cash Balance Plan contributions are invested by the plan’s trustees in a pooled arrangement. There can be no individual account management of plan assets, and IRS regulations do not permit self-direction. This can be confusing, since one of the advantages of a Cash Balance Plan over a traditional defined benefit plan is that participants have individual account balances. Each participant does receive an annual statement showing his or her account balance, contributions and interest credit; however, these are hypothetical. All assets are in fact pooled. (page 32)

Some of these [cash balance] myths are based on out-of-date information. Others arose from an era when major national corporations were converting large defined benefit plans to hybrid plans, creating legal challenges unrelated to the Cash Balance Plan model we use today. (page 47)

Two key dates stand out in the history of Cash Balance Plans. The first is 1985, when Bank of America adopted the nation’s first Cash Balance Plan, and the second is the enactment of the Pension Protection Act of 2006, which affirmed IRS approval and made the plans immune from age discrimination claims. (page 97)

The Self-Employed Individual Retirement Act of 1962, also known as the Keogh Act, makes qualified pension plans available to self-employed persons, unincorporated small business, farmers, professionals, and their employees. (page 101)

1970 More than 26 million private sector workers (45% of all private sector workers) are covered by a pension plan. (page 102)

1980 Almost 40 million private sector workers (46% of all private sector workers) are covered by a pension plan. (page 103)

1990 Approximately 39.5 million private sector workers (43% of all private sector workers) are covered by a pension plan. (page 106)

On September 3, 1993, the US Department of the Treasury issues final 401(a)(4) regulations (Income Tax Regulations 1.401(a)(4)). Section 1.401(a)(4)-8(c) of those regulations creates a “Safe Harbor” for Cash Balance Plans. (page 107)

Several major Cash Balance Plans that were converted from traditional defined benefit plans are in litigation or seeking declaratory judgments over such issues as rate of accrual, whipsaw issues, and age discrimination. These plans include Bank of Boston, Xerox, IBM, and CBS. Another study concludes that Cash Balance Plans now hold more than 40 of all defined benefit pension assets. In the summer of 2003, the Seventh Circuit in Berger v. Xerox Corp. Retirement Plan, decides that the lump sum calculation for workers terminating service prior to retirement who are covered by the defendant Cash Balance Pension Plan cannot violate the rules for defined benefit plans. In a district court in Illinois, Cooper v. IBM Personal Pension Plan decides that the very design of the Cash Balance Plan – the issue that the Campbell court only reached in dicta – has indeed violated the age discrimination rules because the “rate of benefit accruals” did “decrease” on account of the “attainment of any age.” The Lump Sum cases all hold that because Cash Balance Plans are defined benefit plans, they have to abide by the rules for defined benefit plans when the employer calculates the lump sum actuarial present by first accruing the account balance to normal retirement age and then converting the account balance at retirement age into a life annuity before then discounting back to the current date. (pages 108-9)




* These I found questionable:

For contribution increases, the plan must be amended within two and a half months following the end of a plan year or pass nondiscrimination testing on its own. (page 13)

Question 4 of the 2011 Gray book says otherwise.

page 36: ‘loathe’ when they meant ‘loath’

While a relative return based strategy is perfectly acceptable in 401(k) plans or personal investing with long term horizons, it is not appropriate for Cash Balance Plans, which must be marked to market each year. (page 39)

Conversely, during bull markets, these funds often generated excessive returns that reduced the company’s planned tax deduction. (page 41)

Since Cash Balance Plans are still Defined Benefit Plans subject to PPA rules that allow overfunding by up to 50% there is plenty of room for tax deductible contributions these days though what to do with the overfunding that develops is another issue.

If the government believed these plans were not beneficial to employees, they would certainly have taken steps to stop their implementation. (page 48)

This got an ‘lol’ in the margin. It was government regulators who made giving $1,000 to a an older participant (always the principal) the equivalent of giving $88 to someone 30 years younger (even before taking into account any salary differences.)

News stories about underfunded defined benefit plans almost always date from periods of low interest rates. This is due to the inverse relationship between interest rates and liabilities, and the only way to get rid of that risk is to adopt a Cash Balance Plan instead of traditional defined benefit plan. (page 52)

The same funded rules apply so this made no sense to me.

In companies not covered by the PBGC, combined employer contributions to the Profit Sharing plan and Cash Balance Plan are limited to 31% of total eligible pay. For example, if the total eligible payroll is $1 million, then employer contribution to both plans together cannot exceed $310,000 (31% of $1 million). (page 67)

Not quite. and a little more complicated – starting on page 29 here.


4 responses to this post.

  1. Posted by skip3house on February 9, 2018 at 12:26 pm

    Looks as if one (or just a few) agreed to make these’ rules’…Certainly individual common sense is better than the great volume unfunded ‘funds’ we contend with now, protected by self-interest power brokers for politicians’ promises…..


  2. Posted by geo8rge on February 10, 2018 at 10:45 am

    401k is a terrible product that only benefits the extremely rich. At the bottom end of the 401k I personally know people who because of financial difficulty were forced to liquidate paying not only back taxes but a penalty, so it actually cost them money. At the current time low interest rates, which might reflect low future stock returns, make 401ks less useful.

    The cash balance plans putting all wage earners into the same plan seem like a better idea.


    • Posted by skip3house on February 10, 2018 at 11:30 am

      401K type helped me. Got to have some self discipline, not expect government ‘people’ (and taxpayers) to worry for you.
      Though, a controlled savings/pensions using mortality expectations is OK, long as you understand its purpose…using your funds at death to add to others alive.


    • Posted by dentss dunnigan on February 10, 2018 at 11:49 am

      George ..401K plans if used properly a a very good investment never liquidate and entire “pension” plan under any circumstances ,as an extreme last resort they can be used as collateral for a loan .I’ve had one for over 40 years .Yes I wish I could have tapped it back in the 80’s when time were bad but I knew what my goals were ..


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