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The district court held that IBM's cash balance plan violated ERISA because younger workers would earn more years of interest by the time they retired than the older employees would. The district court's holding turned on its interpretation of the phrase 'benefit accrual' in ' 204 of ERISA. The phrase 'benefit accrual' is not defined in ERISA or in any regulation, so the district court used the definition for the phrase 'accrued benefit,' which is defined in ' 3(23) of ERISA as the annual benefit commencing at retirement age. Thus, according to the district court, because IBM's cash balance plan resulted in a lower benefit at retirement for older workers than for younger workers, it violated ' 204 of ERISA.

IBM announced, in September 2004, that it had agreed to settle the lawsuit for an amount not to exceed $1.7 billion; however, IBM appealed the age discrimination claim to the Seventh Circuit. The circuit court overturned the district court's holding, finding that the decreased benefit for older workers was due to the effect of the time value of money, and was not a result of any discriminatory provision in IBM's plan. Specifically, the circuit court held that 'accrued benefit' pertained to what an employee takes out at retirement, the phrase 'benefit accrual' pertains to what an employer credits under the plan. Section 204 therefore precludes employers from reducing the rate of what employers put into a plan, not what employees take out of the plan at retirement.

The circuit court observed that the terms of IBM's cash balance plan were age-neutral. Every participant in the plan received the same 5% pay credit and the same interest credit each year. The circuit court was persuaded by the fact that '[n]either the contribution rate nor the interest rate changes with age.' The Seventh Circuit panel noted that IBM's cash balance plan was 'economically identical to a defined-contribution plan funded the same way,' and did not see any reason why ' 204 would impose a different age discrimination standard on defined benefit plans than defined contribution plans. According to the Seventh Circuit

[i]f the five percent-plus interest formula is non-discriminatory when used in a definedcontribution plan, why should it become unlawful because the account balances are book entries rather than cash?

Notably, Congress recently passed the Pension Protection Act of 2006, which now provides guidelines with respect to what is required to convert a traditional defined benefit plan to a cash balance plan. The provisions of the Pension Protection Act, however, only apply prospectively.

IBM's Cash Balance Plan Did Not Discriminate Against Older Workers

The U.S. Court of Appeals for the Seventh Circuit recently held that IBM's cash balance plan did not discriminate against older workers in violation of the Employee Retirement Income Security Act of 1974 (ERISA), as amended, where the terms of the plan were age-neutral. Cooper v. IBM Personal Pension Plan, No. 05-3588, 7th Cir. 2006.) In so ruling, a three-judge panel for the Seventh Circuit reversed a 2003 decision of the U.S. District Court for the Southern District of Illinois finding that IBM's cash balance plan violated ' 204 of ERISA, which prohibits reduction of an employee's benefit accrual rate based on age.

In 1999, IBM converted its traditional defined benefit pension plan into a cash balance plan, pursuant to which participants would receive 'credits' equal to 5% of the employees' gross income and to a pre-determined interest rate. Under the cash balance plan, when a participant's employment with IBM came to an end, the participant could withdraw his or her account balance as a lump sum, convert the account balance to an immediate life annuity, or defer the receipt of a lump-sum payment or life annuity until a later date. Three plan participants brought a lawsuit against IBM alleging, among other things, that the cash balance plan violated ERISA by discriminating against older workers.

The district court held that IBM's cash balance plan violated ERISA because younger workers would earn more years of interest by the time they retired than the older employees would. The district court's holding turned on its interpretation of the phrase 'benefit accrual' in ' 204 of ERISA. The phrase 'benefit accrual' is not defined in ERISA or in any regulation, so the district court used the definition for the phrase 'accrued benefit,' which is defined in ' 3(23) of ERISA as the annual benefit commencing at retirement age. Thus, according to the district court, because IBM's cash balance plan resulted in a lower benefit at retirement for older workers than for younger workers, it violated ' 204 of ERISA.

IBM announced, in September 2004, that it had agreed to settle the lawsuit for an amount not to exceed $1.7 billion; however, IBM appealed the age discrimination claim to the Seventh Circuit. The circuit court overturned the district court's holding, finding that the decreased benefit for older workers was due to the effect of the time value of money, and was not a result of any discriminatory provision in IBM's plan. Specifically, the circuit court held that 'accrued benefit' pertained to what an employee takes out at retirement, the phrase 'benefit accrual' pertains to what an employer credits under the plan. Section 204 therefore precludes employers from reducing the rate of what employers put into a plan, not what employees take out of the plan at retirement.

The circuit court observed that the terms of IBM's cash balance plan were age-neutral. Every participant in the plan received the same 5% pay credit and the same interest credit each year. The circuit court was persuaded by the fact that '[n]either the contribution rate nor the interest rate changes with age.' The Seventh Circuit panel noted that IBM's cash balance plan was 'economically identical to a defined-contribution plan funded the same way,' and did not see any reason why ' 204 would impose a different age discrimination standard on defined benefit plans than defined contribution plans. According to the Seventh Circuit

[i]f the five percent-plus interest formula is non-discriminatory when used in a definedcontribution plan, why should it become unlawful because the account balances are book entries rather than cash?

Notably, Congress recently passed the Pension Protection Act of 2006, which now provides guidelines with respect to what is required to convert a traditional defined benefit plan to a cash balance plan. The provisions of the Pension Protection Act, however, only apply prospectively.