End Of The Road For Defined Benefit Plans? Not Quite

When talking about defined benefit plans, it’s mostly in the context of how plan assets are being managed with the understanding that the vast majority of these plans are closed to new participants, and plan sponsors are probably considering a risk transfer or lump-sum payouts at some point in the future. But are defined benefit plans truly a thing of the past?

Not entirely, says Emily Hylton, an Atlanta-based senior vice president and investment consultant at Callan. Some employers are still offering defined benefit plans as a means of attracting and retaining talent. Others have shifted to cash balance plans, a type of defined benefit plan that defines the promised benefit in terms of a stated account balance.

Offering defined benefit plans can be a boon for companies that want to attract talent and are willing to take on long-term obligations. In a survey of both Millennials and Baby Boomers, the National Institute on Retirement Security found that the majority of respondents from both groups believe having a pension is important and said they would stay at a job that offered such a benefit. That finding is notable, given that Millennials entered the workforce at a time when pensions were not typically offered. The data suggest that plan participants understand the need for and desire lifetime income but are not totally sure how to achieve that on their own.

“I think what we’re seeing is a recognition that the current system doesn’t work that well,” explains John Lowell, an Atlanta-based partner in retirement consultant October Three. “Even within older age groups that might still have a defined benefit, those participants are working longer and/or may not be able to retire for a whole host of reasons. The first age group that was defined-contribution-only is also now nearing retirement, and many of them are faced with the same issue: Account balances aren’t enough, and when they look at annuities, for example, the lifetime income offered is much less than they anticipated it would be.”

Curves ahead

These dynamics put plan sponsors in a tricky position. Currently, closed defined benefit plans will still be paying out benefits to participants for many decades to come and are unlikely to be reopened. Retirement consultants say plan sponsors are hesitant to take on new long-term obligations because of the associated cost and regulatory hassles . But plan sponsors may end up with a different set of headaches by focusing just on defined contribution plans. Older employees may choose to stay in positions longer, which could limit new hiring opportunities. Younger employees may feel less loyalty to employers if there is no long-term benefit to staying in a role.

There are also issues with sunsetting existing defined benefit plans. Pension risk transfer, liability-driven investing and lump-sum payouts are all tools plan sponsors can use, but each requires certain funded status and often takes a significant amount of time to implement.

“There are trillions of dollars in defined benefit plans right now, and even coming off a big year for pension risk transfer, that solution only represents about 3% of the market,” explains Ari Jacobs, a senior partner in and the global retirement solutions leader at Aon. “I don’t think you can say all defined benefit plans are eventually going to end at a risk transfer. There are too many factors at play, and the plan sponsors we are working with are leaving all options on the table. The other thing to remember is: Each plan is unique, and plan needs will change over time, so we’re seeing plan sponsors try to be as flexible as they can.”

Lifetime income

Arguably, the chief advantage of a defined benefit plan is lifetime income. Whether that income is delivered through the plan itself or eventually through an annuity, the predictability gives participants peace of mind.

However, offering participants lifetime income in defined benefit plans that have lower coverage can be challenging. Risk transfers or lump-sum payouts may solve the equation for plan sponsors, but they can create a new set of issues for plan participants. October Three’s Lowell notes that annuities have a bad reputation with many participants, and lump-sum payouts put participants that were in defined benefit plans in the unique position of having to create a fixed income for themselves, similar to participants in a defined contribution plan.

Hylton notes plan sponsors are faced with a bit of a conundrum.

“I don’t think there’s an appetite to reopen a lot of these plans, but there is a greater recognition that something needs to be done in terms of lifetime income,” she says.

Matt McDaniel, a partner in and the U.S. pension strategies and solutions leader at Mercer, agrees.

“I don’t want to go so far as to say we’re at an inflection point,” he says. “But there are questions about long-term obligations, and we’re also getting data from the first generation of workers that were defined-contribution-only showing that the account balances really aren’t sufficient enough to retire with. As more people retire and that problem grows, I think we could see the tide start to shift back toward something that looks more like defined benefits, but it’s hard to say what that ultimately looks like.”

SECURE 2.0 and the Future

Provisions in the recently passed SECURE 2.0 Act of 2022 seemed to pick up on this dynamic. Lowell notes that cash balance plan-focused provisions fix some of the tax and regulatory hurdles that have kept plan sponsors from offering cash balance plans in the past.

“These provisions haven’t gotten the same attention as others in the [law], but they are important,” he says. “They give plan sponsors the option to do a market-based rate of return such that the assets and liabilities are moving together without the kind of volatility we have seen in the past. That makes it easier for CFOs to model these plans, and when you have cost stability, that makes it more palatable to plan sponsors.”

Other provisions in the law will make it easier for plan sponsors to offer annuities and synthetic annuities to plan participants. Although work may yet need to be done to overcome the hesitancy that plan participants have about adopting annuities, consultants say.

Looking ahead, these provisions offer a base from which plan sponsors can continue to make refinements based on feedback from participants. Mercer’s McDaniel says that rates of product adoption typically determine which solution set becomes the most widely used.

“The retirement space tends to move incrementally,” he says. “If you look back 30 years ago when defined benefit pension plans were common, there wasn’t one single moment when the whole industry shifted to defined contribution. It was an accumulation of changes over time. I think plan sponsors are going to continue to weigh their options and get feedback from participants, and we’ll see more incremental change. So it’s possible we could look up 10 or 15 years from now and things are very different, but it won’t be one moment where everything shifts back to defined benefit. It’s more likely that we end up with something that looks like more of a mix of defined benefit and defined contribution features.”