Plan Change Violated Anti-Cutback Provision

August 16, 2005 ( - An Arizona federal judge has ruled that an employer violated the anti-cutback rule in the Employee Retirement Income Security Act (ERISA) by changing part of its pension formula.

US District Judge Roslyn Silver of the US District Court for the District of Arizona said she was forced to deem the plan in violation because of the legal precedent set by the US 9 th Circuit Court of Appeals in a 2001 case, BNA reported. Silver’s ruling came despite her acknowledgement that plan participants affected by a plan amendment changing the pension formula could end up with the same or higher benefits as before the amendment.

In Michael v. Riverside Cement Co. Pension Plan, appellate judges ruled that ERISA’s anti-cutback rule was violated by a plan amendment providing for actuarial offset of early retirement benefits previously received by a rehired employee upon subsequent retirement, even though the net effect of the amendment was to increase the participant’s retirement benefits.

Silver noted that the Michael case, taken to its logical conclusion, could mean that plan sponsors are precluded from ever changing their benefit formulas, and could actually mean that sponsors cannot convert their traditional defined benefit plans to cash balance plans.

She ruled that separate components of one overall benefit formula are accrued benefits “forever protected from downward adjustment or elimination.”

The court’s ruling could be impacted, however, by the Internal Revenue Service’s issuance August 11 of final regulations that replace former Treas. Reg. §1.411(d)-3 by setting forth conditions under which a plan amendment is permitted to eliminate an optional form of benefit (See  IRS Issues Proposed Regs on Anti-Cutback Rules) .

In a footnote in those final regulations, the IRS noted that they were in response to several court decisions, including the decision in Michael. The IRS explicitly rejected Michael’s interpretation of the anti-cutback rule. Instead, IRS said, “[I]f there are two amendments with the same applicable amendment date, one of which increases accrued benefits and the other of which decreases the early retirement factors that are used to determine the early retirement annuity, the two amendments are treated as one amendment and only violate [the anti-cutback rule] if, after the two amendments, the net dollar amount of any early retirement annuity, with respect to the accrued benefit of any participant as of the applicable amendment date, is lower on that applicable amendment date than it would have been without the two amendments.”

A ‘Floor’ and a ‘Base’ Plan

According to court history, before 1984, Garrett Corp. provided its employees with a pension plan that contained both a defined benefit and a defined contribution component. The plan used a floor-offset arrangement where the defined benefit plan operated as the “floor” plan, while the defined contribution plan was the “base” plan. According to the court, if the base plan provided a benefit at least equal to the minimum established under the floor plan, the participant received the defined contribution account balance as the retirement benefit.

A group of Garrett employees who had participated in the plan before a corporate merger brought a lawsuit alleging that when Garrett’s plan was merged into Signal’s pension plan, their accrued benefits were reduced in violation of ERISA’s anti-cutback rule.

The employees’ complaint focused on plan amendments that changed the structure of the floor-offset arrangement. Under these changes, the interest rate used to project defined benefits forward to normal retirement age was increased retroactively; a Social Security offset attributable to years of service worked prior to introduction of that offset was adopted; and a provision requiring a fractional reduction to the offset for participants with more than 35 years of service was eliminated.

According to the court, the Garrett plan participants admitted that as a result of the merger of their plan with Signal’s plan and the amendments that allowed for such merger, they were better off in terms of benefits. The participants argued, however, that the retroactive elimination or reduction of certain favorable components of the Garrett plan’s floor-offset formula violated ERISA’s anti-cutback rule.

The case is Allen v. Honeywell Retirement Earnings Plan, D. Ariz., No. CV-04-424-PHX-ROS, 7/19/05.