Cash-Balance Plan Conversions: Evidence on Excise Taxes and Implicit Contracts

Firms that wish to switch from a traditional defined-benefit pension plan to a defined-contribution-type plan have a choice between converting to a cash-balance plan or replacing the defined-benefit plan with a full-fledged defined-contribution plan. According to Ippolito and Thompson's (1999; "Industrial Relations", 39: 228-245) excise tax avoidance hypothesis, a number of firms have switched to cash-balance plans because conversion allows the firm to avoid excise taxes on its excess pension assets. In contrast to existing studies, our evidence supports the excise tax avoidance hypothesis. Cash-balance plan conversions also have been criticized for imposing pension losses on older employees. The implicit contract theory of pensions predicts that poorly performing firms would be the ones that would impose losses on employees. However, our evidence indicates that firms converting to cash-balance plans typically are not poor performers. Copyright The Journal of Risk and Insurance.