The Combination of DB and DC Plans. Why Not Have the Best of Both Worlds?
Recently, there’s been a lot of coverage in the media about IBM’s redirecting of its 401(k) matching contribution to a fixed-rate cash balance plan. Some of the coverage has been negative, especially around the potential impact on 401(k) plans and whether this may cause other employers to follow suit. However, when one considers the circumstances of IBM’s current retirement benefits program, it is easier to see why this seemingly drastic change made sense for IBM … and for its employees as well.
That said, it does not mean this strategy makes sense for another company. Each business is different, with its own set of unique financial circumstances, employee demographics and historical retirement benefits. The broader takeaway from the story should be that plan sponsors can use the IBM example as a catalyst to start dialogues about enhancing their own retirement benefits in order to achieve the ideal program for their firms. It’s time to resurrect the lost art of plan design.
First, consider why the change made sense for IBM. The company has:
- An existing (but frozen) fixed-rate cash balance pension plan (the “IBM Personal Pension Plan”),
- With a funding level greater than 100%,
- Containing a large pension surplus,
- Along with a separate 401(k) plan with a nondiscretionary matching contribution.
Accounting for these factors—IBM concluded it could get more “bang for its buck” with respect to its cash flow by using the existing overfunding in the cash balance plan to continue to make contributions for their employees, albeit in the cash balance pension plan rather than the 401(k) plan.
On the plus side for the business, this arrangement improves cash flow and is more efficient for the company since it utilizes excess plan assets to enhance employee benefits. For participants, more individuals will receive the employer pension contribution (not just those who chose to defer), earnings will be stable and predictable, the benefits are insured by the Pension Benefit Guaranty Corporation (PBGC), and there is the added availability of lifetime income options from the pension.
On the downside, employer matching contributions encourage employee deferrals and at higher levels. Consequently, by eliminating the match, it is possible that participation in IBM’s 401(k) plan will decrease, which will not improve retirement readiness for employees.Considerations: Using a Cash Balance Contribution in Place of a 401(k) Matching Contribution
Some say IBM went too far, but it may be that the firm did not go far enough. For example, it could have implemented a combination of pension contributions and 401(k) match. It could have changed the fixed- rate pension contribution formula to a market-value based formula for additional efficiency and smoothing of contributions. The point is—there are so many plan design choices today to consider and, they continue to evolve.
Historically, defined benefit (DB) plans were the dominant retirement benefit offering until 401(k) plans came on the scene in the late 1980s and, through the years, took over the top spot. But 401(k)s were never meant to be the primary retirement vehicle for U.S. workers. It may be that we asked too much of 401(k)s based on their limited structure. Today, worker-need has shifted from asset accumulation to securing guaranteed retirement income. The pendulum is swinging back in favor of DB plans—but not to the legacy designs of the past—but to those that have incorporated defined contribution (DC) elements. Hybrid cash balance designs are soaring in popularity, including the newest arrangements that credit interest based on market performance. The plan design discussion should no longer be limited to picking between one or the other—DB vs. DC, but, potentially, a combination of DB and DC. Why not have the best of both worlds?