Traditional DB to 'Account-Based Plans' Trend Could Soon Ease

October 15, 2007 ( - A new report from the Vanguard Center for Retirement Research suggests the current trend away from traditional defined benefit plans could soon slow down, but a "second wave" of plan freezes may be on the horizon.

The report, Recent Changes to Defined Benefit Plan Design, suggests the slowing in the current plan design trend may come about only because so many DB sponsors have already taken the plunge by moving to an account-based plan – either a cash balance program or a defined contribution offering.

However, future legislative or regulatory changes affecting pension accounting and funding regulations could potentially spark a whole new round of DB changes, Vanguard claimed, “ as sponsors reconsider their commitment to existing DB plans.”

Widespread DB Changes

In general, Vanguard’s survey of more than 125 Vanguard DB plan sponsors indicated six of 10 respondents changed their DB plan design between 2000 and 2006. Most often, the change was a pension freeze paired with a beefed-up 401(k) plan, although hybrid pension designs were important, especially at large firms.

Of those sponsors making DB plan changes, nearly half froze a traditional or hybrid DB design. Some 26% of respondents froze the DB plan for new hires only and shifted the new employees to a 401(k) plan, while 20% froze the DB plan for all employees and shifted all workers to a 401(k) plan, the Vanguard data showed.

A smaller group of sponsors (13%) reduced the generosity of the benefit formula in an existing DB plan. In addition, 28% shifted to a new hybrid plan design. Finally, one in 10 employers expanded DB benefits, either introducing a new DB plan or enhancing benefits under an existing plan.

As of 2007, 51% of survey respondents still offered a DB plan ran it with a traditional formula-based DB pension design for long-service employees. The other 49% of sponsors offered an account-based approach for long-service employees: 23% offered a hybrid DB design and 26% a 401(k) plan only.

According to Vanguard’s data, most new hires were funneled into some type of account-based plan: 60% of sponsors shifted new hires to an all-401(k) arrangement and 26% to hybrid DB plans. Only 14% of sponsors making pension changes offered new hires a traditional DB plan.

In total, 86% of new hires were in account-based plans versus 49% of long-service employees, the Vanguard survey found.

“These results underscore the continued evolution of the private-sector retirement system away from formula-based benefits plans and toward account based programs,” the Vanguard researchers asserted. “Hybrid plans are organized as DB plans under federal law. Yet they appear to participants as growing account balances that earn interest credits. In this way, they more resemble the fixed income component of a 401(k) account than a traditional formula-based DB plan.”

Other Findings

Among the other Vanguard survey findings:

  • Three cost issues – getting a handle on future expenses, smoothing out cost volatility, and trimming current costs- were the top reasons for changing a DB plan design. Sponsors worried about costs were more likely to implement a DB pension freeze, while those focused on employee benefits concerns were more likely to introduce a hybrid DB plan.
  • Just over half of respondents increased employer 401(k) contributions in tandem with alterations to their DB plan -either by adding a new non-elective contribution (28%), beefing up the employer match (9%), or both (16%). The average match rose from 3.4% to 5.2% among plans increasing their match. The average amount of non-elective contribution added was 4.4% of pay.
  • More than one-third of respondents added 401(k) automatic enrollment for new hires when they altered their DB plan designs. Three-quarters of sponsors shifting to automatic enrollment as a result of their DB plan change adopted a balanced or lifecycle fund as the default option. The initial deferral percentage was typically 3% (61% of plans), although a quarter of plans used an initial rate of 4% or higher.
  • Nearly two-thirds of respondents (63%) changed their 401(k) investment menu when they changed their DB plan. About half adopted lifecycle funds and nearly four in 10 changed their default option from a conservative to a balanced or lifecycle fund. Some 13% introduced a managed account program.
  • Among sponsors still clinging to their DB plan, eight in 10 cited various employee concerns as “extremely or very important” in their decision. These reasons included: impact on long-service employees of not offering the plan; desire to provide a secure retirement; negative employee reaction if not offered; and employee perception of the plan’s value.
  • Sponsors were evenly split on the effect of the Pension Protection Act (PPA): half felt the PPA encourages employers to freeze their DB plans; half did not. More than 80% of sponsors agreed the PPA introduced important 401(k) reforms, including new rules on default funds, investments, automatic enrollment and automatic savings increases, and participant advice.

The Vanguard researchers studied responses from 127 DB sponsors. Of this total, 78 had made significant DB benefit design changes between 2000 and 2006. The survey covered employers who use Vanguard recordkeeping or investment services (or both) for their DB or DC plans. The study focused exclusively on DB plans for non-union salaried or hourly workers.

The full survey report is here .