Questions continue to swirl about the relative merits of defined benefit (DB) and defined contribution (DC) retirement plans, particularly in the aftermath of the global financial crisis and the still-tentative recovery. In many ways, DB plans are looking better than ever. What follows is a Q&A that should help to characterize the current lay of the land.
Q: What caused defined benefit (DB) plans to become less prominent?
A: Several issues arising have caused the decline in DB plan incidence. First, they were hard if not impossible for average employees to understand—no understanding implied no appreciation. Second, the plans were decried as less portable than others. Third, DB plans were labeled paternalistic and entitlement-based. Fourth, they were considered too costly.
Q: How do these complaints stack up today?
A: Let’s address them in order. First, it’s true that some benefit formulas were ridiculously complicated even by actuarial standards: multiple fractions, ratios, definitions, averages, social security amounts, lump sum factors. Today, those just aren’t necessary or very common. An account balance with interest and additions are all that’s seen by many participants, thus relying on the same universal math knowledge claimed to make defined contribution (DC) plans so easy to understand. The second and third reasons now appear to be mere confiscations devised to drive change. Portability, for example, was often undefined and actually is a benefit structure rather than plan type issue—portability can be supported or inhibited by DB and DC plans alike. Fourth, cost levels were originally established under very different regimes with different goals. Cost levels of DB plans were high relative to DC plans because the DB was central and the DC plan an add-on to help employees save additional funds, “mad money,” and to use as inflation hedges. Also, many plans had original cost levels reset during the ’80s when high interest rates made doing so appear cost-free. The underlying cost level can be dialed down or up to any level chosen at generally any time. A sideways view of cost level is cost volatility. We now have tools and a regulatory structure that enables us to significantly reduce and better manage cost volatility, enough to make it a non-issue for most of our clients.
Q: If the negatives are gone or suppressed, are there still any good reasons to adopt a DB plan?
A: The main reason these plans became so widespread remains true today: DB plans are more efficient in delivering retirement income security. For example, for a typical company and employee group, the DB plan can deliver upwards of twice the retirement benefit of a DC plan.
Q: Are we seeing widespread recognition of these benefits today?
A: As misinformation is disputed and recent successes identified and affirmed, we have seen a thoughtful reconsideration of plan sponsorship. There are still good cases when DB plans aren’t right for a company or employee group, but there are many more when it is.