On the surface, the battle of pension plans was won by defined contribution (DC) plans long ago. But now, defined benefit plans are making a comeback at some small companies.
It is a particularly unlikely turn of events, since by the early 1980s defined benefit (DB) plans, known more simply as pension plans, had already been in a long decline. Long the retirement vehicle for large companies, these plans began to face troubles as they underperformed, thanks to stagnant equity markets starting in the late 1960s, and, worse, as the companies that provided them began to go bankrupt. Under DB plans, a company guarantees the amount of monthly payments retirees receive for the remainder of their lives.
Enter the 401(k) defined contribution plan. While often seen as less financially rewarding or secure to employees, this plan does have two benefits over the traditional DB plan: It gets the company off the hook for the pension fund's performance and gives responsibility back to the employee to manage his or her own retirement assets. DC plans are so named because they were based on regularly defined contributions by the employee and/or the company to the retirement plan. How it performs is not the company's concern. It's up to the retiree to manage his own retirement assets and make sure he has enough when he's finished working.
Today, less than 25% of the country's private working population have DB plans. But despite that decline, retirees still debate which plans are better. That has thrown the spotlight on public employee pension plans, including Social Security, which are essentially taxpayer-financed DB plans.
Those who recommend DC plans for small businesses-usually in the form of 401(k) plans-can point to some 30 years of market growth. Business owners and their planners can find plenty of cheap and efficient off-the-shelf plans geared to small businesses-plans that can take care of most administrative, actuarial and funding mechanisms.
Despite the seemingly universal success of 401(k) plans, they do have their drawbacks. Indeed, hardly a week goes by that a large mutual fund or insurance company doesn't release a survey detailing how workers are not saving enough to fund their own retirements.
This has led to new small-form or hybrid DB plans, especially the cash balance plan (CBP), designed for the small employer. On a purely numerical basis, the growth rate in CBPs is far outstripping that of 401(k) plans. Yet such numbers must be taken with a grain of salt. As Michael Prendergast, CFP and managing advisor with New York-based Altfest Personal Wealth Management, puts it, most small business owners have never even heard of CBPs. Their extraordinary growth is almost entirely due to the low base they are starting from.
The great benefit to any company with a DC plan is that it is never on the hook to provide retirees with an agreed upon benefit for the rest of their lives-no matter what exigencies, catastrophes (or successes) the company may subsequently go through. DC plans are by definition always "fully funded" (though to the great chagrin of some employees, say those at Enron whose plans were stuffed with company stock, this funding can itself prove to be a chimera).
Congress first acted in 1985 to stop the slide of DB plans and reinvigorate them-through a new channel-into small businesses. Unfortunately, the legislation had legal and financial holes in it and did not have the intended effect. They did not begin to be more widely adopted until the Pension Protection Act of 2006 helped clarify the concerns of business owners, according to Kravitz Inc., an Encino, Calif.-based administrator and manager of retirement plans.
Still, even that fix left problems that were not finally addressed until last November and further clarified by court rulings this spring. But as Prendergast of Altfest Wealth Management notes, many small companies remain ignorant of their potential benefits.