On July 9, 2008, the U.S. Court of Appeals for the Second Circuit ruled in Hirt v. Equitable Retirement Plan for Employees that cash balance plans do not discriminate against older workers, thereby settling an issue that had divided a number of federal district courts (including those in New York and Connecticut) within the Second Circuit.

In holding that a cash balance plan does not discriminate against older workers, the Second Circuit has now joined every circuit court that has considered the issue: the Third, Sixth, and Seventh Circuits. Each circuit has concluded that cash balance plans do not by their design violate ERISA’s prohibition against age-based reductions in the rate of benefit accruals. The appellate decisions in this area are also in accord with the Pension Protection Act of 2006 (PPA), which amended ERISA to specifically allow for cash balance plans; however, the PPA amendment only applies on or after June 30, 2005. Therefore, the PPA did not provide guidance as to whether cash balance plans prior to June 30, 2005 were age-discriminatory. Because of the uncertainty regarding the status of the pre-PPA cash balance plans, the discrimination issues being vetted in courts across the country are still very relevant for many cash balance plans in operation.

In Hirt, the Second Circuit decided the consolidated cases of two unrelated employers who, prior to 2005, had each converted their traditional defined benefit pension plans into cash balance plans. Under one of the cash balance formulas at issue, the employer had agreed to annually credit to each employee’s hypothetical account a pay credit equal to 5 percent of annual compensation up to the Social Security wage base, and 10 percent of the employee’s compensation over that amount, together with an interest credit at a set rate. Under the second cash balance formula at issue, employees with a combined age and years of service under 35 received monthly pay credits equal to 4 percent of monthly salary, with the percentage incrementally increasing for those with a combined age and years of service of 35 or greater, again plus an interest credit at a set rate.

In both cases, groups of participants challenged the cash balance plans, arguing that ERISA prohibits a defined benefit plan from ceasing an employee’s benefit accrual or reducing the rate of an employee’s accrual of benefits on account of a participant’s age. In particular, the participants argued that the “rate of benefit accrual” at which they were earning their pensions under the cash balance formula decreases with advancing age because younger participants’ pay and interest credits in any given year would have a longer period of time over which to grow because of the number of years until retirement. As a result, argued the plaintiffs, younger participants would receive a larger retirement benefit than older participants, in contravention of ERISA.

The Second Circuit Court of Appeals disagreed, concluding instead that the rate of benefit accrual in the context of a cash balance plan should be measured not by the ultimate outcome, i.e., the size of the account at retirement, but rather by the employer’s annual contribution into the plan. According to the court, “the fact that the ultimate benefit might grow to be larger for younger employees – who have more time until normal retirement age than their older counterparts – would not be relevant to the comparison of accrual rates.” Applying the Second Circuit’s reasoning, so long as the rate at which payments (i.e., pay credits and interest credits) made to the employee’s account does not decrease as the employee ages, the cash balance plan does not violate ERISA.