In the past couple decades, many companies have converted their traditional pension plans to cash balance plans in order to make benefits more predictable. But some workers have complained of violations of the Employee Retirement Income Security Act (ERISA) when their benefits are reduced as compared to their former traditional plans. On August 11, the 10th Circuit ruled in Tomlinson et al. vs. El Paso Corporation that employees don’t need to be specifically warned about “wear-away” periods when traditional pension plans are converted to cash balance plans. The court also held that even if older employees are disproportionally subject to frozen benefits, this doesn’t violate the Age Discrimination in Employment Act (ADEA).
A wear-away is the time it takes for a benefit under a new cash balance plan to reach the minimum benefit of the old traditional plan. In Tomlinson, the plaintiffs claimed that the wear-away periods resulting from El Paso’s transition to a new pension plan amounted to unlawful age discrimination, and that El Paso violated the anti-backloading and notice provisions of ERISA (see “Backloading Accusations”). But the 10th Circuit found that El Paso’s transition to the cash balance plan favored, rather than discriminated against, older employees, and that the plan was not backloaded. It further held that “ERISA does not require notification of wear-away periods so long as employees are informed and forewarned of plan changes.”
A five-year transition period for eligible El Paso employees began on the first day of 1997. At that point, employees were credited with a cash balance account equal to the amount payable upon retirement under the old plan. During the transition period, employee accounts were calculated under both the old and the new plans. At the end of the transition period, no additions were made to accounts under the old plan, but credits continued to accrue in the new cash balance accounts. The “minimum benefit” was the accrued benefit under the old plan at the end of the transition period. When employees retired, they could choose the greater of the minimum benefit or the cash balance account benefit.
At the end of the transition period, the minimum benefit for many employees was higher than the value of their cash balance account. For some, the benefit they would receive under the new cash balance plan wouldn’t exceed the value of their minimum benefit under the old plan for several years. The court recognized that during this period, “the accrued benefit payable at normal retirement age is effectively frozen,” and older employees were more likely than younger employees to experience long wear-aways.