State of the Industry
Retirement Life Support
Defined benefit plans continue to offer the guaranteed income participants seek.
In recent years, the retirement plan industry has increasingly focused on ensuring plan participants can create an income stream in retirement. Despite valiant efforts by providers and regulators, income solutions have not been widely adopted in defined contribution plans. Although it has been reported that defined benefit plans have gone, or are going, the way of the dinosaur, even frozen plans offer income opportunities, and there has been a renewed interest in cash balance plan designs.
The 2023 PLANSPONSOR Defined Benefit Administration Survey indicates that most of the 22 million participants represented by service providers surveyed are in frozen (43%) or closed (22%) DB plans. But, in the DB plan world, frozen does not mean lifeless. There’s still work to do to keep participant data clean and monitor the fiscal health of a frozen plan—key areas in which providers can assist. And these benefits are still relevant to the retirement income of all employees that participate in one—from front line to executive.
“Whether large or small, earned benefits from frozen or closed DB plans can represent a strategically important guaranteed income source in retirement,” says Joe McCarty, vice president – retirement and income solutions, with Principal Financial Group in Des Moines, Iowa. “These guaranteed DB benefits also[, in most cases,] come with protection from the Pension Benefit Guaranty Corporation, and most offer participants [an option] that can assist in providing for their survivors.”
Plan sponsors that have frozen their DB plan and supply a DC plan might fail to recognize the inherent opportunity to improve some of their DC plan participants’ retirement income streams. John Lowell, a partner in consulting firm October Three in Atlanta, cites Revenue Ruling 2012-4, issued by the IRS in February 2012, which allows for transferring assets from a DC plan to a DB plan and converting those assets into lifetime income.
The idea was introduced around the turn of the century when Bank of America wanted to enable its DC plan participants to move assets to the bank’s DB plan for that purpose. “In [Bank of America’s view], there should be no reason an employee couldn’t use his personal DC plan account to get an annuity from the DB plan rather than buying it inside a DC plan—which wasn’t really available back then—or taking a distribution and finding an annuity provider outside of the plan,” Lowell says. “The [bank] asked the IRS, which said the participant would be transferring from one tax-qualified plan to another, very much akin to a plan-to-plan transfer.”
At the time, the IRS’ response was only applicable to Bank of America. However, in 2012, when the agency was making several efforts to expand access to lifetime income options to retirement plan participants, it issued a Revenue Ruling, which applies to plans widely.
With this feature, “you would have language in your defined benefit plan that would specify exactly how that will get converted to an annuity,” Lowell says. “The idea being that it would be done on an actuarially fair basis.”
The option has failed to arouse much interest, over these 11 years, but has not been completely ignored either, he says, recalling one provider’s data showing that 15% of its clients offered participants the ability to perform such transfers.
According to Lowell, the rule says nothing that limits moving DC plan assets only to an active DB plan. He notes that doing such a transfer offers protection from longevity risk, inflation risk and sequence of returns risk.
Moreover, at a time when participants want more personalization in their benefits, the ruling makes way for an additional option whereby they can conform their retirement benefits to meet their needs, he adds.
DB Plan Resurrection
Also meeting needs for plan sponsors and participants are cash balance plans.
McCarty says Principal is seeing renewed interest in the plans particularly under two sets of circumstances: where an industry wants to increase its retirement income alternatives to attract and retain talented high-income earners, or where a company wants to replace a more traditional pension plan design.
“For high-income-earner industries, cash balance plans can provide enhanced retirement savings benefits in a more efficient manner, [allowing] plan sponsors to track benefits while more accurately projecting present and future costs,” he says. Other industries adopt cash balance plans to replace traditional DB plans, he says, so they “can still provide participants a meaningful benefit with lower and/or more controlled costs to plan sponsors.”
According to the 2023 PLANSPONSOR DB Administration Survey, the high-income-earner industries, which are those most likely to offer cash balance plans, are utilities; oil and gas/energy; and law firms.
Lowell says October Three’s own analysis found cash balance plans were also popular with hospitals. “The skilled professional staff at hospitals have very high burnout rates,” Lowell explains. “So the fact that [staff] could accrue a meaningful benefit quickly [via a cash balance plan] is a retention tool.”
Law firms typically use cash balance plans as “deferral opportunities,” he says. Firm partners fund the plan and enjoy tax deductions on plan contributions, plus the benefit-limit in a cash balance plan is much higher than the contribution limits for defined contribution plans. Firms put in fairly generous benefits for support staff as well, to pass nondiscrimination testing, Lowell says.
Contribution limits can be as high as $250,000, McCarty notes.
As for other industries, cash balance plans provide a generous benefit for the in-demand talent they hire, and the plans are easy to explain to employees, Lowell says.
It is key for plan sponsors and providers to help participants understand the relevance of DB plan benefits—to explain that “guaranteed income from DB plans can help ensure them some level of core income security to complement their own savings responsibility inherent in defined contribution or individual savings plans,” McCarty says.
High earners will probably respond best to targeted, nuanced communications detailing the added savings capabilities the plans make possible, he says.
In sum, he says, “Both designs, traditional DB or cash balance, offer employers an opportunity to have flexible benefits and talk to their employees about good retirement outcomes.” —Rebecca Moore
The 2024 DB Administration Survey showcases the providers that support DB plans.