A recent article by Vanguard addresses the apparent tradeoff of interest rate risk for investment risk when converting a traditional pension plan to a cash balance pension plan. A couple of quick thoughts on this topic:
- This is likely true for a traditional corporate pension plan where the plan sponsor has to worry about the effect of FASB pension accounting results on their balance sheet. For small plan sponsors that don’t follow GAAP accounting, they are usually solely focused on the investment risk and making sure that investment returns keep up with the interest crediting rate.
- The author states that is it generally difficult to invest to match a cash balance plan interest crediting rate (e.g., the 30-Year T) or you sacrifice a lot of potential asset return if you have a lower interest credit rate (e.g., the 10-Year T). This is the traditional way of looking at cash balance interest credit rates, but I don’t entirely agree with these statements for a couple of reasons.
- Although it has proven difficult to exactly match the 30-Year T, large corporate cash balance plans should have a long enough time horizon such that they can get close in most years and hit the target over the long-term.
- For smaller cash balance plans, having a low interest crediting rate is not necessarily a bad thing. Often these plans are set up for the deduction opportunity, not for potential asset return. Shareholders or other participants in these small plans usually choose to take their investment risk outside of the cash balance plan.
