Home > Library > Stable Times > Volume 4, Issue 3  

Bank of America Swap Offer to 401(k) Participants Has Implications for Defined Contribution Plans and Stable Value

For two decades, corporate America has had a love affair with the 401(k) plan. Now, Bank of America Corp. is rethinking that relationship—with potentially significant implications for the stable value industry and the pension industry at large.

On July 1, Bank of America gave participants in its $6.7 billion 401(k) plan a one-time, two-month window of opportunity to roll their assets out of that plan and into the company's $8 billion cash-balance pension plan. The potential benefit to the company is obvious: if Bank of America can earn more on the transferred assets than it ultimately pays out in benefits, it will enhance its bottom line, either by foregoing contributions to the pension plan that it otherwise would have been required to make, or by actually booking some of its excess investment gains as income. This is a luxury the company has already tasted; last year, pension income added $149 million to Bank of America's total pretax income of $12.2 billion.

Plan participants who elect to make the swap will be able to allocate their transferred assets among "virtual" mutual funds designed to track the performance of the in-house funds currently available in the bank's 401(k) plan. But that's largely a record-keeping exercise that will allow Bank of America to compute employees' investment returns. The managers of its cash balance plan will actually be able to invest the assets in whatever manner they choose. Their goal, of course, will be to match or better the virtual returns of the employees who have swapped 401(k) assets into their plan.

Investment experts say that shouldn't be too hard for Bank of America to do, at least over the long-term. "The company is taking the assets of individuals with a 10-to-20-year investment horizon and transferring them to an institutional plan with an investment horizon of 40 to 75 years," says a retirement attorney at a large benefits consulting firm. "The plan can be much more aggressive with those assets than could an individual."

Still, the offer is not without risk, especially since Bank of America has agreed to lock in the value of any assets transferred to the cash balance plan. That means a participant who swaps in $100,000 would be assured of getting that $100,000 out upon retirement, even if his or her account loses money in the interim. Over the short term, that's always a possibility.

"Promising an employee a specific return (i.e., one based on their asset allocation choices) with no downside risk doesn't sound like the sort of business I'd like to be in," remarks a pension executive at one Fortune 500 company. "Yes, it can work. But it can also boomerang big time."

Implications for Stable Value in Defined Contribution Plans

Were it to become widespread, Bank of America's maneuver could lead to reduced use of traditional defined contribution investment vehicles, including mutual funds and stable value products. While 401(k) participants as a group make sizeable allocations to stable value funds, managers of defined benefit plans, including the cash-balance variety, almost never do. (The book-value accounting that makes stable value products appealing to investors in defined contribution plans isn't allowed in defined benefit plans.) A Bank of America spokeswoman confirms that while its 401(k) participants had 13% of their assets in stable value investments as of August 9, the company's cash balance plan had none. (Interestingly, both plans had high allocations to equity; 84% in the case of the 401(k) plan, and 68% in the case of the pension plan.)

"From a stable value industry perspective, you need to be alarmed, clearly," remarks Ted Benna, creator of the first 401(k) plan and now president of the 401(k) Association, a third-party plan administrator in Bellefonte, Pennsylvania.

Still, there are reasons to believe that corporate America will not embrace the Bank of America model en masse. For one thing, the model depends upon the availability of a cash balance pension plan, which allows for the maintenance of individual participant "accounts" with a unique asset allocation mix in each one. Although cash balance plans have become increasingly popular in the past few years, they still represent a minority of all defined benefit plans. "Cash balance plans, due to their regulatory constraints and complexity, are going to be limited to a certain number of companies," says one industry observer. "You're not going to have a universal move to this approach."

"I don't think it's going to become commonplace," agrees William Quinn, president of AMR Investment Services, the $14 billion pension arm of AMR Corp. "The overall trend is in the opposite direction; companies are trying to get people off their defined benefit rolls and onto the defined contribution rolls." AMR operates a traditional defined benefit pension plan as well as two 401(k) plans, one for its pilots and the other for its other employees.

David Wray, president of the Profit Sharing/401(k) Council of America, also points out that Bank of America can't count on its employees to remain as conservative with their investment allocation decisions, once they're in the cash balance plan, as they were when their assets were housed in the 401(k) plan.

"If I'm a rational employee, I'm going to put 100% of my money into equities because the bank is now guaranteeing me all of the underlying protection of a cash balance plan plus a floor on my return," Wray says. "In that situation, the bank probably wouldn't be able to outperform the investment allocation by employees. The success or failure of their program may depend upon whether employees figure out that they can have their cake and eat it, too."

Some outside observers also fret that the Bank of America model could face regulatory hurdles. Even though the company received a favorable determination letter from the Internal Revenue Service on its cash balance plan a few years ago, when the company was still called NationsBank, the Wall Street Journal reported in June that regulators have since become concerned about the plan's design, especially its definition of normal retirement age as either 65 years of age or five years of service. The five-years-of-service definition, if adopted elsewhere, could allow some companies to circumvent the accrual rules set down by both the IRS and the Employee Retirement Income Security Act. Those rules are designed to prevent employers from backloading benefits in favor of highly compensated employees.

Absent the accrual rules, a company could make an unusually large contribution to an employees' pension benefit after that employee logged many years of service. The fear is that highly paid employees are much more likely to stay with one employer than are low-paid employees, and that the latter group would therefore be discriminated against. Since accrual rules expire at normal retirement age, though, an employee who met that requirement through five years of service could legally receive a large backloaded pension benefit.

That's not an issue with Bank of America's cash balance plan as its currently structured. The plan calls for the company to make contributions ranging from 2% of pay for the shortest-tenured employees to 8% of pay for the longest-tenured employees. However, the formula also takes an employee's age into account, so an older, short-tenured employee could get a higher percentage than a younger but longer-tenured employee.

Bank of America notes simply that it hasn't run afoul of the IRS. "In view of not having received any comments from the IRS on the current plan, it would be speculation on our part to assume they have any concerns," a Bank of America spokeswoman says.

Meanwhile, Benna notes that assets in a pension plan are insured by the Pension Benefit Guaranty Corp., but those in a 401(k) plan are not(1). Because the premiums paid by plan sponsors to the PBGC are based on the number of participants in their plans, rather than their assets, "this is kind of a back-door way of getting PBGC protection around a large block of 401(k) assets without paying an increased premium," Benna says. "I don't know how policy makers will react to that."

Whatever the implications for the pension industry, Bank of America's plan seems to offer a win-win outcome for employees. In addition to getting PBGC protection for their accounts and a principal guarantee, Bank of America is allowing them to take up to two loans from their vested pension plan account at any time. (The company has, however, eliminated the loan feature from its defined contribution plan.)

Bank of America says that despite its swap offer, it has no plans to discontinue its 401(k) plan. Participants who elect to transfer assets into the cash balance plan may continue to participate in the 401(k) thereafter, but will have to begin building their account balances from scratch.

The company says its swap offer was part of a restructuring of its 401(k) and cash balance plans that included simplifying and changing the contribution formula for the cash balance plan and improving the company's 401(k) contribution schedule (the company now matches employee contributions dollar-for-dollar up to 5% of pay). It says those changes will increase the company's retirement plan costs over time.

While no data was available at press time on the number of Bank of America 401(k) plan participants who took advantage of the company's swap offer, historical precedent suggests that it was probably high. Bank of America made a similar offer to its 401(k) participants in 1998 when it was named NationsBank Corp. (Later that year, it acquired Bank of America and took the latter's name.) In that first offer, 74% of the participants in the company's 401(k) plan transferred $1.4 billion of their money into the cash balance plan.

Read Next: Funding Agreement Update