DB/k plans to level playing field
Is it possible to combine the best of DB (defined benefits) plans with the best of DC (defined contribution) plans? The American Academy of Actuaries believes so and it is proposing a new kind of pension fund dubbed DB/k, that is a DB plan with 401(k) features.
The idea is gaining appeal after the recent wave of American corporate scandals. Enron 401(k) plans’ losses due to employees’ heavy investments in their company stocks raised public concern about the current system, where most workers are without protection against the market downturns and CEOs’ shenanigans.
Ron Gebhardtsbauer is the senior pension fellow of the American Academy of Actuaries who elaborated the idea of a DB/k plan and advanced it in a congressional hearing last summer. He observes that in the US “the playing field for retirement plans is not level. Plans with 401(k) features can have pre-tax employee contributions, matches (from the employer and the federal government), phased retirement at age 59?, market returns, and many other items that DB plans cannot have. In addition, pension laws over the past two decades have made DB plans more expensive to administer than DC plans”. He mentions a study by the Hay Group, which shows that in 1980 the administrative costs of a 10,000 person DB plan were less than the costs of a similar-sized DC plan, but by 1996 the DB costs had grown dramatically to almost 50% more than the DC plan’s ones.
Gebhardtsbauer acknowledges that younger and mobile employees like more 401(k) plans, because they are portable, they offer larger benefits in the early years and are more understandable. But he is a strong advocate of DB plans’ advantages to employees, employers and the whole nation.
“For employees,” Gebhardtsbauer explains, “DB plans are more likely to provide a secure stable income for life. Employees won’t have to worry about a bear market when they want to retire or after they retire.” Secondly, DB plans are more flexible for employers, who can contribute more in good years and less in difficult years. “And for the nation – the Academy’s pension expert concludes - DB plans help reduce poverty rates better at the older ages”.
The hybrid DB/k plan should be organised as one trust fund with some elements that DC plans already have. It should allow employees to voluntary contribute pre-tax dollars and it should allow employer matches. Employees should be able to immediately participate at hire and retire at age 59. And they should also be offered the choice among different investments, as it happens already in ‘self directed cash plans’. In the latter, plan members have individual account with performances linked to stock or bond indexes. The employer may also decide to offer a minimum guaranteed return.
“At the same time the new plan could have some features from DB plans that policy makers have expressed an interest in such as: automatic qualified joint and survivor annuities as the default option; reduced administrative expenses; funding, investment and design flexibility; guaranteed minimum returns (if the employer so desires and possibly for a charge); and PBGC guarantees on account balances and amounts transferred from DC plans,” says Gebhardtsbauer. The latter feature reportedly puzzles PBGC – the Pension Benefit Guaranty Corporation – which is the federal pension insurance agency.
Gebhardtsbauer points out that the academy does not want to design a very specific plan: “The main purpose is to make the rules more flexible and to level the playing field for DB and DC plans”. Implementing the idea would anyway requires changes in the tax code and possibly ERISA (Employee Retirement Income Security Act) and would have to win congressional approval.