In Tomlinson v. El Paso Corporation, the United States Court of Appeals for the Tenth Circuit recently held that El Paso Corporation’s transition to a cash balance pension plan did not violate federal anti-age discrimination and pension laws. In doing so, the court offered important guidance to employers that provide pension benefits to their employees.
What is a cash balance plan?
In a cash balance plan, a percentage of an employee’s pay, along with interest, is credited to an account each pay period. Upon retirement, the employee is entitled to receive the proceeds of his or her cash balance account. The main difference between a cash balance plan and a 401(k) plan is that an employer guarantees the interest rate that applies to the proceeds of a cash balance account, in contrast to a 401(k) plan that shrinks or grows with the market. A third alternative, the “final average pay” plan, offers a retired employee a percentage of his or her final average earnings multiplied by his or her years of service. Final average pay pension plans have, over time, become more and more difficult for employers to fully fund.
Tomlinson v. El Paso
In 1997, Houston-based El Paso Corporation converted its traditional final average pay plan to a cash balance plan. Although it was not required to, El Paso also provided a transition period during which employees accrued benefits under both the old formula and the new cash balance formula. After five years, benefits under the old formula were frozen, while cash balance benefits continued to accrue. If an employee retired during the transition period, he or she was entitled to receive benefits under whichever formula was most favorable.
In 2004, three employees filed a class action lawsuit against El Paso in federal district court in Denver. They claimed that the Company’s conversion to a cash balance plan discriminated against older workers in violation of the Age Discrimination in Employment Act. According to the Plaintiffs, when the five-year transition period ended, the frozen “final average pay” benefit was usually more valuable for older workers than the cash balance benefit. Because of that gap, they claimed that they did not earn any additional retirement benefits while the cash balance benefit caught up to the frozen final average pay benefit.
The Plaintiffs also alleged that the Company had violated several technical provisions of the Employee Retirement Income Security Act.
The Tenth Circuit’s opinion
On August 11, 2011, the Tenth Circuit ruled that El Paso’s conversion to a cash balance plan was legal, as were the means the company utilized to transition to the new pension plan. In coming to its conclusions, the court first explained that “wear-away” periods are caused by giving a transition period that employers are not obligated by law to give. The court refused to punish El Paso for giving a benefit it was not obligated to give in the first place. Second, the court recognized that the cash balance benefit continued to grow equally for everyone, irrespective of the age of the employee. Finally, the court noted that older workers had the option of choosing the “frozen” final average pay benefit rather than the cash balance benefit, if, indeed, any employee found that to be more valuable.
The court also made clear that when employers make major changes to their pension plans they must give notice of those changes to employees. The court analyzed and approved the notices that El Paso sent out to its employees, making specific and detailed findings regarding what employers must include in Summary Plan Descriptions – and what they need not include – when changes are made to pension plans.
Tips for employers
The Tenth Circuit’s decision provides helpful guidance to any employer that offers pension benefits. In particular, the decision highlights the importance of making sure that any plan change is accompanied by straightforward, honest disclosures to employees.
- Strictly comply with ERISA’s notice requirements: Employees are entitled to receive notice of plan amendments before the changes go into effect. ERISA and its regulations lay out specific requirements concerning the content of the notices. Failure to comply with the requirements can, in a worst case, lead to nullification of a plan amendment.
- Resist the urge to candy-coat plan changes: Employers often want to focus only on the positive aspects of plan changes because they are more motivational. Courts will closely analyze whether an employer’s communications were deceitful or failed to accurately describe negative aspects of changes to a pension plan.
- Don’t be afraid of cash balance plans: Cash balance plans are an excellent retirement vehicle. The plans provide stability and certainty to employers and employees in ways that 401(k) plans, which are subject to the volatility of the market, cannot.
Darren E. Nadel, shareholder at Littler Mendelson P.C. Employment and Labor Law Solutions Worldwide, can be contacted at 303-629-6200 or firstname.lastname@example.org.
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