What does the term "Pension Wear-Away" refer to?

The term "Pension Wear-Away" refers to a situation that can arise when an employee transitions from one type of retirement plan to another, specifically from a cash balance plan to a defined benefit (DB) plan. In this context, the wear-away occurs when the employee's future retirement benefits may not increase or may even decrease after the switch due to differences in how benefits are calculated in each plan.

Cash balance plans credit employees with a set percentage of their salary, and this can lead to a scenario where an employee's accumulated benefits under the cash balance plan exceed what they would receive under the terms of the new DB plan after the transition. As a result, the employee may experience a "wear-away" period where they do not gain any additional benefits, even if they continue to accrue to the DB plan, effectively leading to a loss in expected benefits.

This makes it crucial for employees to understand the dynamics of switching plans, as it can significantly impact their retirement savings trajectories and overall financial planning for retirement.