Backloading
Link to Case
Keywords: ERISA, backloading, cash balance plans, notice
Panel: Jacobs, CJ, Wesley, and Crotty (SDNY)
Opinion by: Wesley
Appeal from: SDNY (Scheindlin)
Result: Reversed
A somewhat surprising, technical decision that permits Citigroup to skirt ERISA prohibitions against “backloading,” which occurs when a pension plan awards covered employees disproportionately higher benefit accruals for later years of service.
Plaintiffs are present or former employees of Citigroup entities (”Citi”) who alleged that the Citbuilder Cash Balance Plan (the “Plan”) violates the Employee Retirement Income Security Act of 1974 (”ERISA”). The district court granted summary judgment to plaintiffs, concluding that the Plan was a “deliberate end-run around statutory guidelines that effectively kept the Plan’s accrual rates below the minimums prescribed by Congress” that had been inadequately explained to Plan beneficiaries. Slip Op. at 21-22 (quoting district court). Several district courts in other circuits have applied similar reasoning. Slip Op. at 24 n. 7. Nonetheless, the Second Circuit reverses the award of summary judgment to plaintiffs and orders the complaint dismissed.
The Plan is a a hybrid of the two primary types of retirement plans – defined contribution plans and defined benefit plans. In the former, the employee bears the risk of performance; in the latter, the employer does. Hybrid cash balance plans like the Plan “create a benefit structure that simulates that of defined contribution plans, but employers do not deposit funds in actual individual accounts, and employers, not employees, bear the market risks”. Slip Op. at 7 (quotation citation omitted). Plan accounts are “hypothetical” and don’t represent actual, segregated assets; employers keep virtual accounts and pay employees a lump sum upon retirement.
Backloading, as indicated, is prohibited by ERISA. To prevent it, ERISA sets forth three alternative minimum benefit accrual tests, two of which are implicated in this appeal. Under the “133 1/3 test,” the rate of benefit accrual in any future year “must be not more than one-third greater than the rate in the current year.” Slip Op. at 14. The Plan flunks that test due to changes in the variable interest rate. Under the “fractional test,” an employees accrued benefit for any given year must be “proportionate to the number of years of service as compared with the number of total years of service appropriate to normal retirement age.” Id. (quotation citation omitted). The Plan provides that when the rate of accrual does not meet the 133 1/3 test, “participants’ accounts will be made to comply with the fractional rule of accrual upon the termination of the period of employment.” Slip Op. at 16.
Under the text of the statute, compliance with the fractional test is measured upon separation from service, not on a year-by-year basis. This interpretation is supported by IRS revenue rulings, which are “entitled to great deference” and “have the force of legal precedent unless unreasonable or inconsistent with the provisions of the Internal Revenue Code.” Slip Op. at 29. Thus, under the fractional test,
“adjustments are made to departure-time benefits to ensure that the participant is not penalized for leaving prior to normal retirement age. The rate of benefit accrual during a participant’s employment is unimportant under this test, as long as proportional benefits are paid at the time of departure.”
Slip Op. at 26 Accordingly, the court concludes that the Plan does not violate ERISA’s strictures against backloading. In addition, the Plan’s notices were sufficient under the notification requirements then in effect; the court expresses no opinion whether those notices would satisfy current law, which requires sufficient information “to allow applicable individuals to understand the effect of the plan amendments.” Slip Op. at 32. n. 5.
