A supplemental defined benefit (DB) longevity plan may be able to reduce pension costs for employers and offer employees an annuitized source of income during their later years in retirement. In their paper “Longevity plans: An answer to the decline of the defined benefit plan,” Milliman consultants Bill Most and Zorast Wadia provide an example of these advantages.
Let’s take a look at a cost example of a 2-percent-of-pay career average plan for a participant hired at age 45 and terminating at age 65. We’ll further assume a starting salary of $60,000 and a 2.5 percent salary scale. This would result in a salary of roughly $106,500 just prior to termination.
The participant’s life annuity benefit commencing at age 75 would be about $31,000 per year. If the participant’s benefit were to be funded over that person’s working career of 20 years, the annual employer cost to fund this benefit would be about 1.8 percent of pay. By comparison, if the participant’s retirement benefit were to commence at age 65 under current Internal Revenue Service rules, the annual employer cost to fund this benefit would be about 2.5 percent of pay.
Thus, by limiting benefit eligibility until age 45 and by not allowing benefits to commence earlier than age 75, the cost of this plan would be relatively low to fund. Using this same example, while extending benefits commencement to age 80, the employer’s cost would be significantly lower at about 1.5 percent of pay.
Having a longevity plan with a simplistic design in which only life annuities can be offered directly addresses the issue of longevity risk… Aside from single life annuities and 75 percent joint and survivor options for married participants, no other types of benefits would be allowed. Lump-sum amounts will presumably be available via a retiree’s defined contribution plan and personal savings.
Collecting an annuity benefit from the supplementary defined benefit plan would not preclude a retiree receiving a lump-sum benefit from the defined contribution plan. It would just make it easier for the retiree to make decisions on how best to manage his or her lump-sum benefit from a withdrawal and consumption perspective; the participant would know exactly when his lifetime annuity benefit would start, no earlier than age 75 in our proposed plan. Early retirement would be restricted from the proposed longevity plan because the concern is for the latter years of retirement and the understanding is that other sources of savings should be enough to get retirees through the initial years of retirement.