New Adjustable Pension Plan Looks Promising
One of the problems many employees have faced over the last decade is the rapid disappearance of the traditional company pension plan – also known as a defined benefit (DB) plan – in favor of defined contribution (DC) plans. With DB plans, the investment risk is completely borne by the company, while the opposite is true of DC plans (the employee takes on all the risk). You’d think someone would have come up with some kind of shared-risk model that avoids such an all-or-nothing approach to an employee’s retirement success.
Finally, someone has. Pensions And Investments magazine reports that there is a new pension plan design that allows employers to drastically reduce their risk while still providing lifetime income to participants. The key difference from a traditional DB plan is that the benefit received each year is adjusted from an original multiplier based on the previous year’s investment performance. The plan design thus shares the investment risk between employees and employers while providing more retirement income security than a typical DC plan.
“It might be a lower benefit than the traditional defined benefit plan, but at least it’s secure,” said an official from the Pension Benefit Guarantee Corporation (PBGC), which guarantees DB plans. The official added that the adjustable plan is more cost controlled than a traditional DB plan and not as dependent on big contributions.
What differentiates the adjustable plan from a cash balance plan, another traditional hybrid DC/DB plan, is that the cash balance plan benefit is determined by a benchmark such as 10-year Treasuries, while the adjustable plan’s benefit depends on actual investment performance of the plan.
An early adopter of such a plan is Consumers Union and its union, the Newspaper Guild of New York. They plan to create an adjustable pension plan that will replace the standard DB plan for guild members starting June 1. The New York Times also switched to the new adjustable plan for its members who are part of the same union. Under the Consumers Union plan, the employer will contribute a fixed 6% of salaries plus $100,000 each year. The New York Times will contribute about $9.5 million to its plan this year and a similar amount after that based on a formula. However, both plans still need approval from the Internal Revenue Service, and that is not scheduled to occur before mid-2014 for The New York Times and early 2015 for Consumers Union. If the plans do not receive approval by those dates, they will revert to new defined contribution plans instead.
“It will vastly reduce risk and volatility for the company and still provide a lifetime payment and PBGC insurance,” said William O’Meara, president of The Newspaper Guild of New York. “We’re hoping that this becomes a national model for others to adopt. There is some upside potential and very little downside for employees” compared with participant risks in a defined contribution plan.
I am personally encouraged by the development of such a plan, which has great potential to reduce much of the investment risk that retirees have been forced to accept without consequent training and advice. While not a panacea for retirement success, it may both provide a more secure stream of income to retirees and reduce the likelihood of pension underfunding on the part of employers and plan administrators.