Outline of Comments Introduction I. The Treasury Department’s proposal for cash balance plans would reopen the door to age discrimination in rates of accrual that Congress closed in 1986 II. The proposed regulations endorse “larger accruals for younger employees” contrary to Federal law and policy in effect for over 16 years III. The proposed regulations would not even require employers who sponsor cash balance plans to make equal contributions for older workers IV. Contrary to statements from the White House and the Treasury Department, the proposed regulations for cash balance plans are not the same as for defined contribution plans V. The conversion methodology in the proposed regulations draws from Code section 417(e) but omits the key statutory requirements of written consent by the participant and his spouse and an actual distribution of the benefits VI. The proposed regulations are inconsistent with the IRS’s previous analyses of cash balance plans in both the first Bush and Clinton Administrations A. The IRS’s proposed 1988 regulations B. IRS Notice 96-8 C. The Treasury Department’s prior statements to the Senate Finance Committee and its “friend of the court” brief for the United States Court of Appeals VII. The Treasury Department does not have the authority to change the laws that Congress enacted A. Treasury’s regulations fail the United States Supreme Court’s "Chevron" test B. The proposed regulations also trespass on the EEOC’s authority to enforce the ADEA’s general prohibition on age discrimination in employee benefits VIII. If the Administration’s intention is to ratify cash balance conversions despite violations of ERISA’s rules pertaining to accrued benefits, the “regulatory guidance” will be never-ending A. Accrued benefits, and not current balances, must be the basis for lump sum valuations B. Benefit accruals earned before a conversion must be fully, not partially or variably, protected C. Benefits earned after a cash balance conversion must conform with ERISA’s 133 1/3% accrual rule, which does not permit companies to offer “no accruals” for a period of years D. Receipt of benefit accruals earned after a conversion cannot be conditioned on foregoing previously earned rights or benefits E. Advance notice must be given of reductions in future rates of benefit accruals Conclusion Introduction I represent over 25,000 current and former employees of AT&T and over 20,000 current and former employees of CIGNA Corporation in two certified class actions over cash balance conversions: Engers et al. v. AT&T, C.A. 98-3660 (D.N.J.), and Amara et al. v. CIGNA Corp., 01-2361 (D. Conn). The regulations that the Treasury proposed on December 11, 2002 (67 Fed. Reg. 76123), would legitimize age discrimination in these and hundreds of other cash balance conversions, instead of prohibiting it.[1] AT&T and Cigna employees have been financially devastated by their companies’ cash balance conversions. They need the Administration’s and Congress’ assistance to enforce the laws that were enacted to protect older workers against age discrimination. Instead of assisting them, the proposed regulations would allow companies to financially cripple millions of older workers who are approaching retirement. For the reasons described below, we urge the Treasury Department to withdraw this proposal and replace it with one that protects the rights of older workers. I. The Treasury Department’s proposal for cash balance plans would reopen the door to age discrimination in rates of accrual that Congress closed in 1986. Congress enacted ERISA in 1974 to protect the retirement incomes of employees by establishing minimum standards for company pension plans. In 1986, Congress amended ERISA and the ADEA to put an end to widespread practices under which older employees were excluded from benefit accruals. Congress prohibited any discrimination in rates of benefit accrual based on age. [2] When Congress enacted the 1986 law, it expressly provided that a company with a “defined benefit plan” is tested for age discrimination on the basis of whether it offers equal annuities to older workers, i.e., a defined benefit plan must provide that older workers earn additional monthly retirement benefits at the same rate as younger workers. II. The proposed regulations endorse “larger accruals for younger employees” contrary to Federal law and policy in effect for over 16 years. The preamble to the Treasury Department’s proposed regulations admits that cash balance plans produce a “larger accrual for younger employees, when measured as the increase in the benefit payable at normal retirement age.” 67 Fed. Reg. 76126. Contradictorily, the regulations would permit this. Without explanation, the proposed regulations just declare a sweeping exception to the law for "eligible cash balance" plans, which currently cover over 8 million employees. No policy justification is offered. Indeed, the proposed regulations do not even acknowledge the disastrous impact that cash balance conversions have on the retirement benefits of older workers. The proposed regulations would reopen the door to the abuses that Congress closed over 16 years ago. For example, under the AT&T and CIGNA plans, the rate of accruals for employees who are over 60 can be as low as one-half of the rate of employees who are age 30. Under the proposed regulations, millions of older employees like these would labor in the last years of their careers with lower annual rates of accruals than are offered to younger employees. III. The proposed regulations would not even require employers who sponsor cash balance plans to make equal contributions for older workers. Under “wear-away” designs, hundreds of thousands of older employees are working without earning any additional pension benefits. Under these designs, older workers enjoy not just lower but no additional benefit accruals for a number of years of employment. This is clearly inconsistent with Congress’ 1986 mandate. Sections 4(a) and 4(f) of the ADEA require employers to offer equal benefits or alternatively to incur equal costs for older and younger workers. An employer is not allowed to justify lower costs, or no costs, for older workers in the current year by referring to pay or benefits that they enjoyed in earlier years. Under section 4(i) of the ADEA, as added in 1986, employers who sponsor defined benefit plans must provide equal benefit accruals for older and younger workers. The Treasury Department’s proposed rules for cash balance plans would not enforce the law requiring equal benefits, and would even not require employers who sponsor cash balance plans to make equal contributions. The proposed regulations provide that a cash balance plan will not be considered discriminatory if a company offers “hypothetical” contributions at the same rate for all employees. Although this can be phrased to sound equitable, it is obviously different than the test that Congress enacted for defined benefit plans. The proposed regulations fail, moreover, to address the cash balance designs adopted by many large employers, including AT&T and CIGNA, under which “hypothetical” pay credits are offered to everyone, but actual contributions are only made for younger employees, and not for older, longer-service workers. Under these “wear-away” designs, the hypothetical pay credits only go with converted account balances; they do not add to the annuities earned before the date of conversion. For older employees, the converted account balances are much less valuable than the annuities earned prior to the date of conversion. An older employee receives no actual payments from the employer’s “hypothetical” cash balance contributions until his accumulated account balance surpasses the value of his previously accrued benefit. As a result, the company’s “hypothetical” pay credits do not add to the older employees’ benefits but remain purely hypothetical for a number of years. For younger employees, the employer’s hypothetical pay credits are the same as actual contributions. This glaring hole in the protections against age discrimination is opened up through conversion methodologies that the proposed regulations endorse. In conversions from traditional defined benefit plans to cash balance plans, many companies set up opening account balances that include less than 50% of the value of previously earned benefits. Some employees ultimately learn that the benefit that has been valued for the balance is the one that they would receive at age 65, not the more valuable benefits that they will receive at age 55. For older employees, the difference between a valuation of their benefits at age 55 or 65 can be hundreds of thousands of dollars. For younger employees, the difference between the two is non-existent or negligible. Establishing opening account balances substantially below the value of the benefits that older employees previously earned creates the frozen benefit status for older employees that has been called “wear-away.” For many older employees this means that they receive no additional contributions or benefits for the rest of their careers. When AT&T converted to a cash balance plan in 1997, its consultants prepared spreadsheets showing that its “wear-away” design only applied to employees over age 43. The longest periods of “no accruals” were for employees 7 years from early retirement. The proposed regulations condone these “no accrual” conversion designs by indicating that a participant will be treated as if he is adequately protected as long as he or she receives the “greater of” two amounts: (1) the frozen benefits earned before the conversion or (2) a cash balance account whose initial value has been set so low it will never surpass the frozen benefits. 67 Fed. Reg. 76127 and Prop. Reg. 1.411(b)-2(b)(2)(iii)(C)(3) and (E). The underlying mathematics allows employers to make no contributions for older, longer-service employees. Congress enacted the age discrimination laws to prevent exactly what these regulations are permitting. The “first alternative” in the proposed regulations would not have this effect. Under the first alternative, each participant’s benefit must be “not less than the sum of the benefits accrued under the traditional defined benefit plan and the cash balance account.” As the IRS correctly observes “a plan satisfying this first alternative will not have a wear-away period for benefits accrued under the traditional defined benefit plan.” 67 Fed. Reg. 76127. Under this method, hypothetical pay credits translate to actual contributions for both older and younger workers. However, the second “greater of” methodology endorses age discrimination for no evident purpose other than to ratify or legitimatize existing conversion practices. The IRS never explains what statutory policy of the ADEA is served by permitting a second alternative that is always worse than the first. In all other contexts, moreover, the IRS has recognized that the net benefit accrual must be tested for discrimination. For example, the proposed regulations recognize that the rate of benefit accrual under a “floor offset plan” must be determined “after taking into account the amount of the offset.” 67 Fed. Reg. 76129. Under a “greater of” methodology, the rate of accrual would logically be tested as the net increment, too. A cash balance conversion that causes older but not younger employees to experience “wear-away” is discriminatory because employees do not actually receive equal contributions “regardless of age.” Employers like AT&T are incurring no costs and paying no additional benefits to older employees for up to 10 years. An employer does not satisfy either an equal benefit or an equal cost rule when older workers’ benefits are subject to conditions that are not applicable to younger employees. IV. Contrary to statements from the White House and the Treasury Department, the proposed regulations for cash balance plans are not the same as for defined contribution plans. William Sweetnam, benefits tax counsel at the Treasury Department, has stated that the proposed regulations require cash balance plans to satisfy the "same rules that defined contribution plans have to satisfy, because they accumulate the same way as defined contribution plans." Vineeta Anand, “No Discrimination; Cash Balance Plans Pass Muster with Treasury,” Pensions & Investments (Dec. 9, 2002). White House press spokesman, Ari Fleischer, has echoed that analysis. Asked whether the proposed rules are unfair to older workers, he stated that “they would apply to cash balance plans . . . in the same way the rules apply to defined contribution plans.” [3] These statements are simply inaccurate. Defined contribution plans are required to actually deliver contributions to older employees on the same basis as younger employees. Defined contribution plans are not permitted to use “hypothetical” contributions that are paid to younger employees, but not to older employees. When a cash balance plan is designed to “wear-away” previously earned benefits, benefits do not “accumulate the same way as defined contribution plans.” Defined contribution plans are required to make equal actual contributions to both older and younger workers. The IRS’s proposed regulations would allow cash balance converts to circumvent both the rules for defined benefit plans and the rules for defined contribution plans. V. The conversion methodology in the proposed regulations draws from Code section 417(e) but omits the key statutory requirements of written consent by the participant and his spouse and an actual distribution of the benefits. The conversion methodology in Prop. Reg. 1.411(b)-2(b)(2)(iii)(E) that permits wear-aways is pulled from Code section 417(e). However, Congress enacted Code section 417(e) for lump sum distributions made to participants with the informed written consent of the participants and their spouses. [4] In cash balance conversions, there is no consent to the conversion by the participant or his spouse and there is no actual distribution of any funds. Companies converting to cash balance are just extracting interest and mortality rates from section 417(e) while ignoring the rules in the same statutory section that were enacted to protect employees and their spouses. In addition to the problems with this methodology described above (no benefit accruals), there is no explanation about how the IRS determined that it is appropriate for benefits to be converted to cash balance accounts using the standards in section 417(e) but without the written consent of the participant and his spouse and the right to actually receive the previously earned benefits. Without an actual distribution, benefits are not realized and may decline prior to receipt (as described more fully at pp. 26-27 below). Moreover, Treas. Reg. 1.411(a)-11(a)(2), as issued in 1988, provides that an accrued benefit must be “valued taking into consideration the particular optional form in which the benefit is distributed.” The proposed regulations would permit companies to convert accrued benefits to cash balance accounts using the “normal” form of benefit without regard to the greater value of optional forms. VI. The proposed regulations are inconsistent with the IRS’s previous analyses of cash balance plans in both the first Bush and Clinton Administrations. The proposed regulations are inconsistent with the IRS’s previous analyses of cash balance plans. A. The IRS’s proposed 1988 regulations In 1988, the Treasury Department issued proposed regulations that would have enforced the 1986 law as enacted. 53 Fed. Reg. 11876 (April 11, 1988). Although those regulations were never made final, taxpayers were authorized over the next 15 years to “rely on these proposed regulations for guidance pending the issuance of final regulations.” In fact, this guidance continues to be in effect. [5] The 1988 proposed regulations provide that “any differences in the rate of benefit accrual . . . may not be based, directly or indirectly, on the attainment of any age.” The regulations proposed in 1988 did not contain any exception to these rules for cash balance plans. [6] B. IRS Notice 96-8 Comparison of the IRS’s analysis in Notice 96-8 with the proposed regulations shows that the IRS has discarded its previous statutory analysis in favor of unjustified conclusions. In Notice 96-8, the IRS recognized: 1. "A cash balance plan is a defined benefit plan, not a defined contribution plan, because the benefits provided are not based solely on actual contributions and forfeitures allocated to an employee's account and the actual investment experience and expenses of the plan allocated to the account. Section 411(a)(7) defines an employee's accrued benefit differently for defined benefit plans than for defined contribution plans. Also, defined benefit plans are subject to a number of statutory provisions that do not apply to defined contribution plans. These include the rules of section 411(b)(1) that limit "backloading" of accruals; the valuation rules of section 417(e); and the definitely determinable benefits requirement of section 401(a)(25). These provisions limit the extent to which a cash balance plan can mimic the benefit and accrual structure of a defined contribution plan. Under section 411(b)(1), the accrual of the retirement benefits payable at normal retirement age must satisfy one of the rules in section 411(b)(1)(A), (B) or (C)." 2. "Under a cash balance plan, the retirement benefits payable at normal retirement are determined by reference to the hypothetical account balance as of normal retirement age, including benefits attributable to interest credits to that age. Thus, benefits attributable to interest credits must be taken into account in determining whether the accrual of the retirement benefits under a cash balance plan satisfies one of the rules in section 411(b)(1)(A), (B) or (C)." 3. "Section 411(a)(7) defines the accrued benefit in terms of benefits payable under the plan at normal retirement age. In a cash balance plan, for an employee who has not attained normal retirement age, whether the employee's retirement benefit payable at normal retirement age under the plan includes benefits attributable to future interest credits depends on whether those benefits have accrued." In the proposed regulations, the IRS announced a completely different position “disregarding interest credits,” with no justification for reversing its views: "These proposed regulations would provide that the rate of benefit accrual under an eligible cash balance plan, as defined in these proposed regulations, is permitted to be determined as the additions to the participant's hypothetical account for the plan year, except that previously accrued interest credits are not included in the rate of benefit accrual. . . . this method of determining the rate of benefit accrual is restricted to eligible cash balance plans, as defined in these proposed regulations." 67 Fed. Reg. 76126. Virtually the same statement appears in three parts of the proposed regulations: 1. "[I]n the case of an eligible cash balance plan, a participant's rate of benefit accrual for a plan year is permitted to be determined as the addition to the participant's hypothetical account for the plan year, except that interest credits added to the hypothetical account for the plan year are disregarded to the extent the participant had accrued the right to those interest credits as of the close of the preceding plan year." Prop. Reg. 1.411(b)-2(b)(iii). 2. "Because Plan N is an eligible cash balance plan, the rate of benefit accrual for Participant A is permitted to be determined as the addition to Participant A's hypothetical account for the plan year, disregarding interest credits." Prop. Reg. 1.411(b)-2(b)(v), Example 3. 3. "The rate of benefit accrual for a participant is therefore permitted to be determined as the addition to the participant's hypothetical account for the plan year, disregarding interest credits." Prop. Reg. 1.411(b)-2(b)(v), Example 5. C. The Treasury Department’s prior statements to the Senate Finance Committee and its “friend of the court” brief for the United States Court of Appeals In an August 23, 2000 letter to the Chairman of the Senate Finance Committee, the Secretary of the Treasury, Lawrence Summers, recognized that “while all participants in [a cash balance] plan may appear to be earning benefits, those participants affected by the wear-away do not accrue additional benefits under the plan until the wear-away period is over. In some cases, wear-away periods extend for a number of years, especially for older workers.” Before the Senate Committee on Health, Education, Labor and Pensions on September 21, 1999, the Chief Counsel of the IRS, Stuart Brown, testified that although a cash balance plan “resembles” a defined contribution plan in some respects, it is “as a matter of law, a defined benefit plan. The plan does not [actually] allocate assets to individual accounts for participants. . . The hypothetical account balance is merely a method for computing th[e] promised benefit. . . . Cash balance plans are . . . required to satisfy a number of . . . tax rules that only apply to defined benefit -- not defined contribution -- plans. For example, . . . the accrued benefit for participants must be defined as provided in section 411(a)(7), and the plan must satisfy rules that relate to the pattern of benefit accrual under section 411(b)(1).” Before the same committee, the Benefits Tax Counsel of the Treasury Department, Mark Iwry, testified that the conversion to a cash-balance plan can be “tantamount to a pay cut” for older employees. In a 1999 amicus brief in Lyons v. Georgia Pacific, 221 F.3d 1235 (11th Cir. 2000), the Treasury Department urged the Eleventh Circuit to adopt the legal principles in Notice 96-8. In its amicus brief, the Treasury Department stated: • "Because a cash balance plan is a defined benefit plan, the accrued benefit under a cash balance plan is the annual retirement benefit payable at normal retirement age under the plan's terms." Amicus Br. at 5. • It would violate ERISA "if plans could compute a participant's lump sum benefit on the basis of the hypothetical amount credited to the participant's account without any regard to the present value of his accrued benefit." Id. at 10. • ERISA's protections "would be rendered largely meaningless if plans could determine the amount of a participant's lump sum benefit on the basis of some formula specified in the plan that ignores entirely the present value of the participant's accrued benefit." This would "circumvent the protections Congress intended to afford plan participants in specifying the interest rates that plans must use in determining the present value of participants' accrued benefits." Id. at 16-17. VII. The Treasury Department does not have the authority to change the laws that Congress enacted. As evidenced by the statements emanating from the White House and Treasury officials, companies who have converted to cash balance plans and their related lobbying associations have convinced the Bush Administration that the age discrimination law can be changed by administrative fiat. However, the Treasury Department is not authorized to change the laws that Congress enacted, but is to “carry out” the laws. Unless Congress expressly authorizes it to do so, the Treasury Department does not have the power to reverse or second-guess Congress’ policy choices by offering exemptions to companies, in this case, politically influential large companies. The Bush Administration also appears to have been convinced, against all the evidence, that older workers are not being hurt by these conversions. But it is indisputable that older employees are not receiving either equal benefits or contributions after cash balance conversions. The proposed regulations condone this, instead of correcting it. Those who are most harmed by the proposed regulations are middle Americans who are already struggling to keep their heads above water amid layoffs, recession, corporate scandals and steep losses in their 401(k) accounts. Their main concern is with their ability to support themselves and their families in retirement. They place their trust in their elected and appointed representatives to enforce the laws against age discrimination. A. Treasury’s regulations fail the United States Supreme Court’s "Chevron" test. Treasury can only interpret the law in its regulations--it cannot make the laws. That is Congress' job. The proposed regulations are ultra vires because the IRS seeks to change ERISA section 204(b)(1)(H) and ADEA section 4(i) insofar as they apply to the subclass of defined benefit plans called cash balance plans. In conformity with a business “wish list,” [7] IRS is seeking to exempt hundreds of cash balance plans from the age discrimination law. This would effect a major change in the age law by removing 8 million employees from its protection. If the regulations are finalized, more companies can be expected to rush to take advantage of the loophole. The leading decision on judicial review of agency regulations is Chevron U.S.A. Inc. v. Natural Resources Defense Council, 467 U.S. 837 (1984). Under Chevron, the courts first look at whether Congress "had an intention on the precise question at issue." If so "that intention is the law and [it] must be given effect." 467 U.S. at 843. In this instance, Congress' intention was that rates of accruals under defined benefit plans were to be tested based on the rate at which the normal retirement benefit accrues. The proposed regulations recognize Congress’ intention for all defined benefit plans, except a subclass of defined benefit plans for which Treasury has constructed “the special definition of rate of accruals.” 67 Fed. Reg. 76125 and 76128. There is no question that the statutory reference to “defined benefit plans” encompasses cash balance plans. The only arguable ambiguity is whether Congress intended for cash balance plans to be tested on some other basis that the IRS could define in its discretion 16 years later. The statutory language indicates that Congress intended for all defined benefit plans to be tested on the basis provided in the 1986 statute. There is no indication that Congress intended for the IRS to develop a special test for cash balance plans that offers less protection to older employees than the general test. “ Final regulations as may be necessary to carry out the amendments made by this subtitle” were to be issued “before February 1, 1988,” by the Secretary of Labor, the Secretary of Treasury, and the Equal Employment Opportunity Commission.” This grant of regulatory authority does not suggest authority to revisit and modify the statute. If Congress' intent is unclear, the courts look at whether the agency is making rules "to fill any gap left, implicitly or explicitly, by Congress." 467 U.S. at 843. Here, even if Congress' intent was determined to be unclear, there is no explicit gap in the legislation for the agency to fill. “If Congress has explicitly left a gap for the agency to fill, there [will be] an express delegation of authority to the agency to elucidate a specific provision of the statute by regulation.” 467 U.S. at 843-44. For example, the same legislation explicitly gives the IRS authority to promulgate regulations for “target benefit plans,” which are a type of defined contribution plan. Code section 411(b)(2)(B) (“The Secretary shall provide by regulation for the application of the requirements of this paragraph to target benefit plans”). Because there is no explicit gap, an implicit gap would have to be found indicating that, despite the statutory directive, Congress did not intend for cash balance plans to be tested for age discrimination as defined benefit plans, but intended for them to be tested on some other uncontemplated basis to be devised in the future by the IRS. Since cash balance plans existed in 1986, it is clear that Congress could have given some indication of an implicit gap for the IRS to fill, but it is equally evident that Congress did not do so. The idea that companies that convert to cash balance plans deserve a special, less protective test for age discrimination is being imposed retroactively by the companies that went ahead, without statutory or regulatory approval, and adopted non-compliant designs. The idea that the IRS is filling an implicit gap in the legislation is also contradicted by the proposed regulations that the EEOC and IRS issued contemporaneously in 1987 and 1988 and by IRS Notice 96-8. None of those pronouncements discern an implicit gap that the IRS needed to fill. If the IRS was nevertheless determined by the courts to be filling an implicit gap, the courts will defer to a "reasonable accommodation of conflicting policies committed to the agency's care by the statute . . . unless it appears from the statute or its legislative history that the accommodation is not one that Congress would have sanctioned." 467 U.S. at 845. The IRS's proposed regulations encounter difficulty on both counts. First, the proposed regulations do not indicate a "reasonable accommodation of conflicting policies committed to the agency's care by the statute." The IRS's proposal does not identify any statutory purpose or conflicting policies that Congress “committed to the agency’s care.” The IRS does not discuss, much less weigh, the Congress' overarching policy of preventing age discrimination in the rate of benefit accruals in defined benefit plans. Instead, the IRS declares an exception, not expressed or implied by the statute, subject to conditions that do not foster the statutory purposes. In essence, the IRS proposes to give cash balance participants the worst of both the defined benefit and the defined contribution worlds: Cash balance accruals would not be tested for age discrimination on the basis of the normal retirement benefit as directed by ERISA for defined benefit plans. At the same time, the IRS’s proposed conditions do not offer participants the protections against forfeitures that adhere to annual contributions made under defined contribution plans. Instead, the employer is permitted to avoid the defined benefit test while only offering “hypothetical” rather than actual contributions to the employee’s account. Second, the IRS's resolution does not appear to be the accommodation that Congress would have sanctioned. Perhaps some future Congress might sanction the IRS's resolution of this policy issue, but it appears that the 1986 Congress (and indeed the 2000 and 2002 Congresses, too) would not have sanctioned the IRS's accommodation. Votes that have been taken in the House and Senate show bipartisan opposition to age discrimination in rates of accruals and wear-aways. B. The proposed regulations also trespass on the EEOC’s authority to enforce the ADEA’s general prohibition on age discrimination in employee benefits Reviewing the regulations proposed on December 11, 2002 and the IRS's 2002 regulatory plan, issued on December 9, 2002, a second problem with Congressional authorization emerges: The proposed regulations trespass on the EEOC’s authority to interpret the ADEA sections 4(a) and 4(f), 29 U.S.C. §§ 623(a) and (f), which prohibit discrimination on the basis of age in any term of employment, including employee benefit plans. In the words of the regulatory plan, the "proposed regulation will . . . address the circumstances in which a conversion from a traditional defined benefit pension plan to a cash balance plan is discriminatory on the account of age." 67 Fed. Reg. 74201. This impinges on the EEOC's authority to enforce sections 4(a) and 4(f) of the ADEA. ADEA section 4(i) only covers benefit accruals; it does not cover conversions of plans from one type of plan to another. Section 4(i) specifically limits the part of the ADEA to which Treasury is given regulatory authority. Whether the conversion of the traditional defined benefit plan to a cash balance plan is on age discriminatory terms is an ADEA section 4(a) and (f) issue that the EEOC is supposed to regulate. This is not a matter over which the IRS possesses any authority or history of enforcement. The proposal that the IRS has produced protects no one save the companies and benefit consultants who negligently or deliberately ignored the age laws in designing these plans. The proposal manifests the reasons why Congress did not charge the IRS with enforcing the general age discrimination prohibition in sections 4(a) and 4(f) of the ADEA. Although the IRS never mentions it, the intention to discriminate on the basis of age in cash balance conversions is evident in many forms. We already mentioned AT&T’s spreadsheets showing “wear-away” only for employees over age 43. Dallas Salisbury, the president of the Employee Benefits Research Institute, recently describes the basic theory upon which companies converting to cash balance plans have acted. “It’s the retired-in-place syndrome. You have employees who are 48 years old, they hate their job, they hate the company, but they know they’ll cross a magic threshold at 50 or 55.” Janice Revell, “Bye-Bye Pension,” Fortune magazine (March 3, 2003). This is exactly the type of age-based stereotype that Congress has prohibited. The age discrimination laws reflect Congress’ policy decision that employers and labor associations must be prohibited from discriminating against employees in pay and benefits on the basis of such gross stereotypes. VIII. If the Administration’s intention is to ratify cash balance conversions despite violations of ERISA’s rules pertaining to accrued benefits, the “regulatory guidance” will be never-ending. When a plan is designed without regard for legal concepts that run throughout the law, the problems can be never ending. As shown by Notice 96-8, ERISA requires that cash balance plans offer accrued benefits expressed in the form of an annuity to comply with several statutory rules. As the IRS recognized in Notice 96-8: “These include the rules of section 411(b)(1) that limit "backloading" of accruals; the valuation rules of section 417(e); and the definitely determinable benefits requirement of section 401(a)(25).” If pay credits substitute for benefit accruals by regulatory fiat in one context, a number of other rules will have to be modified. Attorneys and benefit consultants for cash balance plans have often argued once a critical mass of cash balance conversions has been achieved, they will simply be “too big too fail.” They have audaciously asserted that once many of the nation’s largest companies convert to cash balance plans, the laws will have to be conformed with their non-compliant designs, rather than the other way around. If this occurs, the accommodations the Treasury will have to make will be nearly endless. A. Accrued benefits, and not current balances, must be the basis for lump sum valuations If cash balance designs were to be legitimized without requiring them to conform with the law, the Treasury Department will next have to modify the guidance offered in IRS Notice 96-8 for complying with Code Section 417(e), which appears as a parallel enactment in ERISA Section 205(g)(3), 29 U.S.C. §1055(g)(3). A report by the Department of Labor’s Inspector General released March 29, 2002 finds that cash balance plans frequently underpay workers because they refuse to comply with Code Section 417(e). Numerous court cases have found the same thing: Esden v. Bank of Boston, 229 F.3d 154 (2d Cir. 2000); Lyons v. Georgia Pacific, 221 F.3d 1235 (11th Cir. 2000), Berger v. Xerox, 231 F.S.2d 804 (S.D. Ill. 2002), and 157 F.S.2d 998 (2001), sub nom. Berger v. Nazametz, and Crosby v. Bowater, 212 F.R.D. 350 (W.D. Mich. 2002). Industry lobbying groups led by the ERISA Industry Committee (which is chaired by an AT&T executive) have mounted efforts to modify these rules, too. A May 16, 2002 letter from ERIC to the Departments of Treasury and Labor starts off complaining about the OIG report and ends by asking the Departments to “revoke” Notice 96-8. It urges that cash balance plans should only have to pay out the “current balance” in the cash balance account without reference to the annuity benefits that ERISA requires to be accrued. B. Benefit accruals earned before a conversion must be fully, not partially or variably, protected Paying participants current cash balance accounts rather than annuity benefits not only deprives them of their statutory rights under Code section 417(e), it can also mask that their annuity benefits have not grown since the cash balance conversion. Indeed, in many cases, participants would be unable to repurchase the annuities they had before after cash balance conversions. There are two principal reasons for this: First, in converting previously earned benefits to cash balance accounts, many employers, including CIGNA, apply pre-retirement mortality discounts. However, as the participants grown older, the decreased risk of mortality is never credited back. As a result, the annuities that participants are able to repurchase with their original cash balance accounts are, even with interest, less than the annuities that they originally had. When interest rates fall below the conversion interest rate, as they have over the past 5 years, this situation becomes even worse. Effectively, cash balance conversions have transformed the defined benefits earned before the conversions into variable annuities that can decrease when interest rates drop. In the Cigna class action, we asked an actuary to review an example of an individual with an annuity of $1,000 per month payable at age 65 that is converted to an opening account balance using 6.1% interest and GATT mortality. The opening account balance earns interest at 5%. When the participant separates from service, the account balance is projected for the remainder of the period to age 65 at 5%. The projected account balance at age 65 is reconverted to annuity form using 5% interest and GATT mortality. The actuary found that after 10 years, the participant ends up with an annuity of approximately $600, instead of the original $1,000. If cash balance plans are to be legitimized regardless of their problems, the IRS will have to issue new regulations on ERISA section 204(g) providing that such decreases do not constitute reductions in previously accrued benefits. C. Benefits earned after a cash balance conversion must conform with ERISA’s 133 1/3% accrual rule, which does not permit companies to offer “no accruals” for a period of years. The Second Circuit’s decision in Esden v. Bank of Boston, 229 F.3d 154 (2000), establishes that cash balance plans can only comply with one of ERISA’s accrual rules, the “133 1/3%” accrual rule. This accrual rule provides that the rate of accruals in any later year can never exceed 133 1/3% of the rate of accruals in any earlier year. IRS regulations issued in 1977 prohibit an accrual pattern under which a participant has no accruals for a number of years. 42 Fed. Reg. 42334 (Aug. 22, 1977). The preamble to the proposed regulations describes how rates of accruals are based on a “year-by-year” determination “that does not accommodate averaging over a period of earlier years.” 67 Fed. Reg. 76129. Thus, “if a higher accrual is provided for older workers in one year, the rates cannot be leveled out in subsequent periods in a manner that takes the earlier higher accruals into account.” Id. To legitimize wear-aways under ERISA’s anti-backloading rules, those regulations would have to be modified, too. ERIC and other associated groups have been lobbying the Treasury Department to modify its anti-backloading rules to permit a pattern of accruals that has been prohibited for more than 25 years. The regulation that ERIC et al are lobbying Treasury to modify says that an accrual pattern of 2% of highest average pay in first 5 years of participation, followed by 1% in years 6-10, and then 1.5% in all years thereafter does not comply with the 133% rule, notwithstanding that the average rate of accruals is never less than 1.5%. 26 C.F.R. 1.411(b)-1(b)(2)(iii), Example (3). This example shows that cash balance formulas with wear-aways cannot comply with ERISA’s anti-backloading rules. D. Receipt of benefit accruals earned after a conversion cannot be conditioned on foregoing previously earned rights or benefits. The preamble to the proposed regulations states that "a defined benefit plan must separately comply with the requirements of section 411(a), which are not addressed in these proposed regulations." 67 Fed. Reg. 76125. Section 411(a) contains ERISA’s vesting rules. Thus, the regulatory preamble indicates that legal issues about whether the "year-by-year rates of accrual" are forfeitable in violation of the vesting rules are not addressed in the proposal. Treasury Regulation 1.411(a)-4, promulgated in 1977, provides that a right that is conditioned upon subsequent forbearance or other events “which will cause loss of such right is a forfeitable right at that time.” As a result, “if benefits . . . have accrued [but] those benefits are disregarded when benefits commence before normal retirement age, the plan has effectively conditioned entitlement to the benefits . . . on the employee not taking a distribution prior to retirement age.” IRS Notice 96-8. Wear-aways condition the right to post-conversion benefit accruals upon giving up part of the benefits earned before the conversion. In Esden v. Bank of Boston, 229 F.3d 154, 158 (2000), the Second Circuit held that payment of part of an employee’s accrued benefit cannot be “made conditional on the distribution option chosen.” Moreover, a plan sponsor cannot “have it both ways” by claiming compliance with ERISA’s 133 1/3% accrual rules, but then conditioning the actual right to payment of part of those benefits on a “particular form of payment.” 229 F.3d at 167-68 and 173. As another federal judge has written: Conditioning receipt of the post-conversion benefit accruals “on giving up receipt of the other benefit . . . would certainly appear to violate 203(a)'s requirement that a vested employee be provided with 100% of their accrued benefit, without forcing them to first give up one benefit in exchange for receiving another one." E. Advance notice must be given of reductions in future rates of benefit accruals “accruing for a year” As shown in still another set of proposed IRS regulations, ERISA section 204(h) requires the benefits “accruing for a year” under a cash balance plan to be compared with the benefits “accruing for a year” under the prior plan. Prop. Reg. 54.4980F-1(b), Q&A 6 and 8, 67 Fed. Reg. 19713 (Apr. 23, 2002). We understand that ERIC and other organizations have been lobbying the IRS to modify these regulations, too, to condone accrual patterns in which no benefits are earned for a period of years. Conclusion The Treasury Department does not have the authority to “make laws” ratifying or legitimizing cash balance designs that violate the ADEA and ERISA. If the Treasury Department continues on this path, it will, absent judicial intervention, wreck the retirements of millions of Americans. It will also forever jeopardize the Treasury Department’s standing as an agency that Congress can trust to “carry out” laws enacted to protect the pensions of older employees, rather than make an end run around the laws in concert with politically influential companies and their associated lobbying groups. For older workers who are approaching retirement, the proposed regulations represent permanent, real life disasters on a unprecedented scale. I request to testify in person at the April 9, 2003 hearing. Dated: March 13, 2003 Corrected: March 14, 2003 _____________________ Stephen R. Bruce [1] The proposed regulations are not retroactive. 67 Fed. Reg. 76129 and Prop. Reg. 1.411(b)(2)(f)(3). But companies are already citing them in lawsuits involving earlier cash balance conversions. Moreover, the reference to 'plan years beginning on or after the date of publication of final regulations' is ambiguous when earlier conversions have continuing effects. [2] On July 24, 2002, the House of Representatives reaffirmed the prohibition on age discrimination in ERISA and the ADEA by a vote of 308 to 121. In April of 2000, the Senate adopted a 'Sense of the Senate' resolution regarding cash balance conversions, resolving that 'Federal law should continue to prohibit pension plan participants from being discriminated on the basis of age in the provision of pension benefits' and that 'pension plans that are changed to a cash balance or other hybrid formula should not be permitted to 'wear away' participants' benefits in such a manner that older and longer service participants earn no additional pension benefits for a period of time after the change.' Cong. Record (April 7, 2000), at S-2415. [3] Available online at http://www.whitehouse.gov/news/releases/2002/12/20021210‑11.html#4 [4] IRS regulations require disclosure if any other benefit option could be more valuable to the participant. Treas. Reg. 1.401(a)-20, Q&A 36, promulgated August 19, 1988. See also Treas. Reg. 1.411(a)-11(c)(2) (material features of optional forms must be disclosed). [5] The December 11, 2002 proposal provides that 'until these regulations are adopted in final form, the reliance provided on the 1988 proposed regulations continues to be available.' 67 Fed. Reg. 76129. [6] The EEOC also issued proposed regulations on November 27, 1987, which did not suggest any exception for cash balance plans. 52 Fed. Reg. 45360. [7] According to the New York Times, 'getting clearance for these pension plans was near the top of businesses' wish list.' Richard Oppel, 'Administration Supports Rules that Can Alter Pension Plans,' New York Times (Dec. 10, 2002).