Court of Appeals Upholds Cash Balance Plan’s ERISA § 204(h) Notice

November 30, 2009

In a decision with important implications for sponsors of defined benefit pension plans, the 2nd Circuit Court of Appeals ruled that Citigroup gave proper notice under Section 204(h) of the Employee Retirement Income Security Act (ERISA) of reductions in future benefit accrual rates in the Citigroup cash balance plan. The ruling reverses a district court decision that could have permitted plaintiffs to mount broad challenges to pension plan amendments that reduced future accruals.

ERISA § 204(h) and Pension Plan Amendment Litigation

ERISA § 204(h) prevents a plan sponsor from significantly reducing a defined benefit pension plan’s rate of future benefit accrual unless timely notice (a 204(h) notice) is given to participants. ERISA and the Internal Revenue Code require defined benefit plans to issue 204(h) notices 45 days prior to the effective date of a plan amendment that causes such a reduction. Among other requirements, a notice must include a description of the benefit formula prior to the amendment, a description of the benefit formula under the plan as amended, and the effective date of the amendment.

An “egregious failure” to provide 204(h) notices to all participants can result in a participant receiving his or her benefit without regard to the amendment. In addition, if a pension plan fails to provide the required notice, an excise tax of $100 per day per failure can be imposed.

In recent years, plaintiffs lawyers have filed several ERISA class action lawsuits challenging pension plan amendments under ERISA § 204(h). Cash balance plan amendments have been frequent targets of such litigation, as the Citigroup cash balance plan litigation illustrates.

Citigroup Cash Balance Plan

Cash balance plans are defined benefit pension plans that express each participant’s benefit in terms of a hypothetical account balance. Typically, participants receive annual credits to their accounts of a certain dollar amount or percentage of salary, plus interest on their hypothetical balance.

Proponents of cash balance plans often believe that such plans are superior to traditional pension plans, because cash balance plans are easier for employees to understand and allow them to accrue benefits more evenly over their careers. Critics argue that cash balance plans are unfair to older employees who do not accrue benefits in their later years as rapidly as they would have under a traditional pension plan.

Citigroup’s cash balance plan (the Citibuilder plan) was created in 2000 by converting a traditional pension plan into a cash balance plan through a plan amendment. This amendment changed the Citibuilder plan’s benefit accrual formula and the method it used to comply with ERISA’s minimum benefic accrual rules.

As part of the conversion, Citigroup issued a 204(h) notice to Citibuilder plan participants in advance of the amendment. Citigroup’s 204(h) notice included descriptions of the prior and future benefit formulae. The description did not explain how the amended plan would satisfy ERISA’s minimum benefit accrual rules, which are technical, mathematical tests designed to prevent “backloaded” benefit accruals. Specifically, Citigroup designed its benefit accrual relying in part on the “fractional test” to satisfy the minimum benefit accrual rules. However, Citigroup did not disclose this test as part of the 204(h) notice.

In 2002, Citigroup amended the Citibuilder plan again to reduce benefit accrual rates. Citigroup issued another 204(h) notice describing the amendment. This 204(h) notice also did not discuss the plan’s use of the fractional test to satisfy ERISA’s minimum benefit accrual rules.

Class Action Suit and Lower Court Ruling

In 2005, current and former employees of Citigroup filed a class action lawsuit in the Southern District of New York, alleging that the Citibuilder plan violated ERISA. Plaintiffs claimed that the plan unlawfully discriminated against older participants and had an unlawful accrual formula. Plaintiffs also asserted that the 204(h) notices of the 2000 and 2002 plan amendments were inadequate, such that those amendments never took effect.

After both parties moved for summary judgment, the district court ruled that the Citibuilder plan discriminated on the basis of age and violated ERISA’s minimum accrual rules, because in the district court’s view, “career average” plans like Citibuilder cannot use the fractional test to comply with minimum accrual rules. The district court also concluded that the 204(h) notices’ warnings of benefit accrual rate reductions were legally insufficient, because they did not include a discussion of the plan’s “unorthodox” and “improper” use of the fractional test in satisfying ERISA’s minimum accrual standards. Thus, the district court held that the entirety of both the 2000 and 2002 amendments to the Citibuilder plan never took effect.

The district court’s ruling implied that any defect in a defined benefit plan could become a 204(h) violation if that defect potentially impacted benefit accruals. Moreover, the court’s opinion also seemed to indicate that a 204(h) violation could invalidate an entire plan amendment. This raised the disturbing possibility that even a technical defect in a defined benefit plan could lead to subsequent amendments being ruled invalid in litigation years later, exposing plan sponsors to massive potential liability.

Court of Appeals Reverses and Holds That Notice Was Sufficient

The court of appeals reversed the district court, holding that the Citibuilder plan’s provisions did not violate minimum accrual rules or discriminate based on age. The court of appeals also ruled that a qualification defect in a plan amendment does not render a 204(h) notice defective, so long as the notice properly describes the change in benefit accrual rates.

The court of appeals specifically rejected the district court’s view that the fractional test could not be used in testing a career average cash balance plan. Not only was use of the fractional test not a defect, but the 204(h) notice did not need to explain that the fractional test was used to meet minimum accrual standards. The court of appeals emphasized that Citibuilder complied with ERISA § 204(h) by providing a summary of how the amendments worked and alerting participants that amendments could result in a reduction of future benefit accruals.

The court of appeals cited with approval the amicus curiae brief of the American Benefits Council, represented by McGuireWoods LLP. The American Benefits Council argued in support of Citigroup that the district court’s interpretation of ERISA’s anti-backloading tests conflicted with the plain language of ERISA and IRS guidance, and created needless uncertainty and risks in designing defined benefit pension plans.


The Citigroup case illustrates the risk that plaintiffs may seek to use ERISA § 204(h) to challenge pension plan amendments based on alleged technical defects in the sponsor’s notice to participants. It is also a reminder that 204(h) notices must be carefully drafted and provided to participants in a timely manner. All amendments to defined benefit plans (and other retirement plans subject to the Internal Revenue Code’s minimum funding standards) should be carefully evaluated for any provision that could potentially decrease the rate of benefit accruals, thus requiring a 204(h) notice to participants.

In addition, last week, the IRS and the Treasury Department issued final regulations regarding 204(h) notice requirements. These regulations provide further guidance for plan sponsors that intend to modify how benefits are accrued under their plans.

For an explanation of the new final regulations and assistance with implementing or drafting plan amendments and 204(h) notices, please contact the authors or any member of the McGuireWoods Employee Benefits or Labor & Employment teams.