Defined Benefit Plans Live On as Older, Wise Neighbors, Where DC Plans Can Borrow Ideas
Although some have asserted the pension could roar again for private-sector workers, traditional final-pay pensions are effectively obsolete, as a plan design, in the corporate workplace, sources said.
Despite that, the final pay defined benefit plan—a workplace pension plan arranged to pay a vested participant retirement income for life based on salary at retirement or average salary—does have a bright future ahead, only not as a prevalent retirement solution in the future, explain academics and plan sponsor benefit experts.
However, defined benefit plan features, designs and philosophy have powerful lasting effects for the future of defined contribution plan designs and therefore will live on well into the future, explains Judy Bobilya-Feher, chief financial officer, at Aunt Millie’s Bakeries.
“[Defined benefit plans aren’t] necessarily dead or frozen like they’re said [to be] right now,” she says. “It maybe seems like they’re frozen but the concepts that we’re talking about for our retirees and [like in-plan] annuities [are] right into that world, so I don’t think they’re dead by any means.”
Informed by academic research in behavioral economics and experiences with workers, defined contribution plan sponsors have copied many features of defined benefit plans to improve employees retirement outcomes. As defined contribution and defined benefit retirement arrangements each have several significant flaws, both designs should borrow—like neighbors—from one another, says Feher.
The future for defined benefit plans requires not throwing out the DNA of pension plans. Instead some deliberate thinking from the retirement industry is required, wherein defined contribution plans must meet their predecessor retirement plans to bolster workers’ retirement outcomes, say sources.
Greater ‘SECURITY’
The Secure 2.0 Act of 2022, a package of retirement reforms, made modest modifications to defined benefit plans.
“The basic story is the same: In the private sector, DB plans are going away and they’re never coming back,” says Alicia Munnell, director, at the Center for Retirement Research at Boston College and the Peter F. Drucker Professor of Management Sciences at Boston College’s Carroll School of Management. “I view [the SECURE 2.0 changes] as tiny and nothing really that will change the trajectory of these plans.”
The new legislation could curtail further defined benefit plans, explains Teresa Ghilarducci, professor of economics and policy analysis at the New School for Social Research.
SECURE 2.0 included more requirements for defined benefit plans with additional disclosure in the annual communications, says Ghilarducci.
She seconded that neither of the SECURE laws, including the SECURE Act of 2019 made large or helpful changes for DB plans.
“SECURE 2.0 is more of the same: Congress for the past 20, 30 years now, really favoring defined contribution plans and really punishing defined benefit plans,” says Ghilarducci. “SECURE 2.0 gave a lot more requirements for defined benefit plans [and] there’s more disclosure in the annual communication.”
The 2022 bill did include some better guidance for “pension risk transfers and [some] other things, [but] I view them as tiny and nothing really that will change the trajectory of these plans,” says Munnell.
The two retirement reform packages in the past three years plotted improvements to DC plans by adding into DC plans -features that make them operate more like defined benefit funds.
Borrowing From Pensions For 401(k)Plans
Critical to porting over optimal DB features to DC plans to make them more useful is shared responsibility for workers’ retirement, with shared risk—between employer and workers for retirement. It is important to ensure that the onus for decades of saving, investing through market volatility and finally, decumulation, is not solely on the shoulders of plan participants.
“One of my concerns [for future DB plans] would be heavily employer contribution related, and didn’t get a lot of participant contribution,” says Feher.
A plan design that blends participant salary deferrals and employer retirement contributions—in a plan designed with increased worker security, lower employer costs and higher total assets for workers—leading to a more optimal retirement outcome for workers by using defined benefit type features, but with greater portability would be ideal, adds Feher.
The optimal retirement plan design is some combination of the best of both worlds: the portability of DC plans with the lifetime security offered by pensions in a plan design that creates risk-sharing for the bulk of contributions and investments, between employers and workers, experts say.
“Ideally, [the U.S] would want to move towards some system of risk sharing so that neither the employer nor the employee bore all the risks,” adds Munnell.
U.S. retirement plan designs could be informed by Canada and the Netherlands. Both countries provide national models, which the U.S. could borrow or follow, she says.
“They do [share risk] in the Netherlands and Canada…but we don’t do it here and so we’ve got this extreme where we have DB plans [on one hand] where the employer bears all the risks and we have the [DC] plans where the employee bears all the risk,” explains Munnell.
Pension Prevalence
Workplace pension plans will persist in lesser numbers and be limited to certain industries, says Brett Dutton, head of investment strategy and analysis for nonprofit, pension and insurance solutions, at Vanguard Group.
While corporate pension plan sponsors have reduced benefits, frozen and terminated defined benefit plans for private sector workers, public employees remain more likely to be eligible.
“There are certain employers, certain industries, certain employer types, that recognize the long-term value of having a defined benefit plan—probably in conjunction with a defined contribution plan, not instead of the defined contribution plan—so believe that there is a long-term future for defined benefit, believe that some employers have recognized that it’s a valuable benefit to attract and [will use it to] retain highly motivated employees,” he says. “There is a long-term future for defined benefit plans, because some employers see it as a differentiation tool.”
Final salary pensions are expensive for employers because the plan sponsor must be able to pay out benefits to eligible beneficiaries, even after the lifetime of the plan participants.
In February, LIMRA data showed 70% of retiree respondents said between Social Security, traditional pensions and annuities, they expect to have sufficient lifetime-guaranteed income to cover all their basic living expenses. However, workers without a traditional defined benefit pension will have to patch together their sources for guaranteed income in retirement.
“In the state [and] local area, we will continue to see defined benefit plans,” says Munnell. “The employer [has a] broader [funding source] in the sense that it’s taxpayer and the workforce is less mobile and so it would seem a place where they can work.”
Defined benefit plan have advantages over defined contribution plan in three main ways, says Ghilarducci.
“You can’t opt out of the defined benefit plan,” she says. “If you work for an employer with one and you’re eligible you’re in, you’re a participant: you can’t opt out. And that means that you’re accruing credits or in the case of a DC plan, you’re accruing assets despite your yourself.”
In fact, she adds, “when I was a trustee of the Indiana Public Employees Retirement System, we let our participants save their money in the defined benefit system, so that they got the rate of return that the defined benefit system gets, which is about one or 2% higher than they could get elsewhere.”