The federal district court for the Southern District of New York recently ruled that defining a plan’s normal retirement age (NRA) by years of service violates ERISA if it makes the NRA earlier than age 65. It also follows a majority of courts by ruling that cash balance plans are not inherently age-discriminatory.
Court Rules NRA Definition Invalid
The case involved PricewaterhouseCoopers' (PwC’s) cash balance plan, which defined the NRA as the earlier of age 65 or five years of service. PwC used that definition attempting to avoid the “whipsaw” calculation that forces certain cash balance plans to pay lump sum benefits higher than participants’ notional account balances. Under the whipsaw calculation, lump sum distributions are calculated by projecting the benefit forward to NRA based on the plan’s interest crediting rate, then discounting back to the distribution date using a statutory interest rate. If the plan’s crediting rate is higher than the discount rate, the lump sum benefit will exceed the participant’s account balance — and the longer the duration of the discount period, the higher the excess amount. Setting the NRA at five years of service eliminated the whipsaw calculation, PwC argued, since every vested participant has already attained NRA.
The plaintiffs claimed that defining retirement age by years of service violated ERISA, thus rendering PwC’s five-years-of-service definition of NRA invalid. That being the case, plaintiffs argued, PwC’s plan should have projected the balance of their cash balance accounts forward to age 65 and then paid the present value of that projected balance.
The court agreed, and the ruling requires PwC to recalculate the terminated employees’ lump sum distributions to include interest credits they would have received between the time they left PwC and age 65.
Court Rejects Inherently Age-Discriminatory Claim
The plaintiffs also claimed that the plan was inherently age-discriminatory, but the court disagreed, ruling that the “effect of a younger employee’s pay credits being worth more than those paid to older workers is caused not by discrimination but by the time value of money.” Additionally, the court held that the age-discrimination standards for pension plans do not apply to participants younger than normal retirement age.
Implications for Sponsors
Other plan sponsors that have adopted an “early” normal retirement age may want to reassess the definition in light of this ruling, which may increase the risk that such plans could be targeted for whipsaw litigation. Although the Pension Protection Act resolves the whipsaw issue for distributions on or after August 17, 2006, it does not protect earlier payouts from whipsaw-related lawsuits.