Barry's Pickings | Published in May 2012

We Need a New Plan

Why current plan design models are a failure

By PLANSPONSOR staff | June 2012
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Our current plan design models—defined benefit (DB) and defined contribution (DC) plans—are inadequate and unnecessarily restrict retirement plan design.

Traditional defined benefit (TDB) plans very nicely provide an adequate retirement income for participants, especially those who work their entire career for one employer/plan sponsor. But they create a fundamental problem; because they provide a fixed benefit, not payable until retirement and without regard to asset performance, TDBs create a fixed corporate liability. Generally, investors insist that this liability must be reduced to a present value, using current interest rates.

During the 1980s and 1990s, when interest rates were relatively high, funding TDBs was somewhat inexpensive. With the rates’ steady decline over the last 12 years—with a 100 basis-point decline in 2011 alone—for many companies, the “cost” of TDB plans has become intolerable.

This problem is solved, generally, by freezing or terminating the TDB plan and replacing it with a 401(k) plan, effectively taking retirement savings liabilities, at least with respect to future accruals, off the employer’s books.

However, 401(k) plans create their own problems. To produce an “adequate” retirement benefit, these plans depend on participants contributing early in their careers. Despite 20-plus years of advertising and matching contribution programs—and, more recently, default contributions (automatic enrollment) programs—a sizable percentage of participants remain left behind or have seen their savings “leaked out.” Because 401(k) plans provide for participant asset-allocation decisions (recently mitigated by the use of target-date funds) and a retail mutual fund investment model, with accompanying retail fees, 401(k) plan investments underperform DB investments. (The data here is problematic, but the rate of underperformance appears to be at least 100 basis points.) And, because they pay lump sums, they create a longevity risk problem that has, thus far, proved impossible to solve.