For well over a decade now, defined contribution (DC) plans have been all the rage. Most new retirement plans are DC plans, a lot of which are 401(k) plans. And some defined benefit (DB) plans that do exist are being frozen or terminated and replaced with new or enhanced DC plans. Throughout these changes in retirement plan types, a common question is arising: Is there any room in the retirement benefit world for DB plans?
The answer should be a resounding “Yes.” DB plans should continue to remain relevant because they provide benefit features that can’t be offered in DC plans. This doesn’t mean that DB plans make sense for every employer, but they should make sense for certain employers.
Let’s start with the most obvious difference between DB plans and DC plans. Under a DB plan, employees generally do not bear the investment return risk. Certain employers could see this as a benefit. By offering their employees a DB plan, employers are providing a “guaranteed” benefit that is generally defined by a specific formula. Employees could see this as a much more attractive option than a DC plan.
Some employers may be looking to provide significant retirement benefits. It is possible to allow employees to earn a retirement benefit of up to 100% of their compensation in a qualified DB plan. This level of retirement benefit is not generally available under a qualified DC plan, which is due to the limits on annual employer contributions.
DB plans can be used by employers to better manage their employee workforce. They can be used to either encourage early retirements or incentivize longer tenures, whereas DC plans cannot do either. DB plans can have early retirement eligibility provisions that provide for subsidized early retirement benefits. A typical early retirement provision would allow for subsidized early retirement benefits to be available at age 55 (provided enough years of service have been earned). This allows employees to receive retirement benefits beginning at age 55 and provides an incentive for employers that want a certain portion of their workforces to begin terminating and retiring prior to age 60. In addition, DB plans have the opportunity to offer voluntary staff reduction programs. Employees can be encouraged to retire earlier than they were possibly considering through an early retirement incentive program. DB plans usually provide more valuable benefits for employees that have a longer tenure with their employers. So providing a DB plan incentivizes employees to stay with their employers for a longer period because of the typical benefit structure in DB plans. And employees that are planning on staying with their employers for a long period may seek out an employer that offers a DB plan.
A DB plan may not be the best choice for every employer. However, DB plans should still remain relevant because they can provide features and benefits that cannot be provided by DC plans.