For years, the focus of
Traditional DB pension plans are designed to reward long-term, career employees by providing the largest benefits to those who
Alternative DB plan structures, such as career-average plans and cash-balance plans, emphasize average earnings over a career rather than final average pay. Although these plans tend not to be as generous as traditional pensions, they still allow for a lifetime annuity while distributing benefits more equitably. This ensures that even employees who do not stay with one employer for a very long time still accrue meaningful benefits.
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Regardless of structure, the lifetime annuity is the most important advantage of any pension plan. Even if the annuity accounts for just a portion of a person's retirement income, it provides a safety net he or she cannot outlive. This is very different from a DC plan balance that individuals must manage on their own (or pay others to manage, which has associated costs). Buying an individual annuity also has a significant cost.
Several economic, regulatory and demographic factors have made corporate pension plans much less common in the U.S. over the past few decades. The most significant of these was the introduction of accounting rules requiring plan sponsors to disclose pension plan values each year at the then-current market rate. Corporations could not bear the volatility and impact on their books year to year. It's a real shame because pension plans are meant to be managed and funded over a long horizon. Reducing that horizon to an annual measuring stick was the beginning of the end.
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With the decline in DB plans came a shift toward DC plans, such as 401(k)s, which have become the preferred retirement savings vehicle for many plan sponsors. DC plans transfer the investment risk from the employer to the employee, as the retirement benefits depend on the contributions made and the investment performance of individual accounts.
DC plans are thought of as easier to understand, better for so-called "job hoppers," and less expensive than pensions, but they have relative disadvantages as well. While there is leverage of assets for fees and investment classes offered, a lot of money is paid to the investment community for these plans. Many short-tenured employees lose track of their money, or employees may prematurely withdraw it through loans or distributions, resulting in a loss of compound interest. This leakage really adds up. The biggest issue is that people are substantially left to their own devices to grow and manage their money, and not everyone is equipped to do that.
IBM's pension revival: An edge case?
IBM made headlines when it restored its defined benefit program in early 2024, rekindling interest in pension plans and setting off a wave of articles predicting their comeback. However, it was an atypical case. From what we can tell, the tech giant returned to pensions because the interest rate environment and other factors resulted in a big surplus in its pension fund. Since tax rules have made it untenable to revert the assets to the company, the most effective way to use a surplus is to provide more benefits. So, IBM got great publicity by removing its match (a detail rarely mentioned in press coverage of the story) and adding back its pension (as a cash-balance plan).
Although IBM's situation seems to be an edge case, it's an interesting exercise to consider whether employers and participants could benefit from a pension comeback. Pension plans get a bad rap for being expensive, and, yes, Pension Benefit Guaranty Corporation premiums have grown astronomically. But pensions remain a very cost-efficient vehicle to provide benefits because the money is managed as one big pool by professionals over a long time horizon.
Pensions are also less vulnerable to certain legal risks that plague DC plans. When each employee is responsible for his or her account balance and has a stake in what fees they and the employer pay, lawsuits become prevalent. With a DB plan, the employer contributes amounts calculated by an actuary, so there are checks and balances in place for funding, and it's in the employer's best interest to manage the fees.
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Though many government entities still maintain pension plans, several significant hurdles make their return to Corporate America unlikely. For a true pension revival, we'd need a solution to the requirement to recognize the short-term value of the unfunded liability on corporate financials, either through significant financial reform addressing volatility and cost burdens or by moving away from traditional pensions to alternative formulas like cash-balance plans. Second, these plans need to be adapted to better match the modern employee's desire for flexibility, portability and equitable accruals. Finally, solutions are needed to balance all stakeholders' interests.
A significant shift might only occur in the face of a retirement crisis, such as widespread financial insecurity among retirees. Americans are living longer, which means their retirement savings need to last longer. Over time, our longevity could exacerbate the limitations of DC plans, bringing the need for change to a head.
One potential development is the inclusion of annuities in DC plans, providing a steady income stream similar to pensions. However, the pricing of these annuities remains a major concern. Insurance companies are eager to offer these products, but they often come at a high cost. The market could address this issue through increased competition or the emergence of disruptors. Ultimately, the most cost-effective way to provide annuities is through pooled assets, much like traditional pension plans. This pooling allows for better risk management and lower costs, highlighting a key advantage of DB plans that could inform future retirement solutions.
While the revival of traditional pension plans faces significant hurdles, the exploration of hybrid solutions and innovations in retirement planning could provide a path forward. Employers, policymakers, and financial institutions must work together to create sustainable and equitable retirement options for the future.
