Allow me a bit of nostalgia here…for the defined benefit (DB) plan. If you don’t know what a defined benefit plan is, that’s because it’s a dying breed; and, has been for a number of years. Fortune 500 companies may have a defined benefit plan, many times because a union insists on one. Some smaller companies have one, sometimes out of a genuine concern for their employees and, more often, because it can provide a large tax deduction.
Significantly fewer people today are covered by a defined benefit plan than when I started in this business 28 years ago. At that time, 90 percent of the work I did was on defined benefit plans. Now, they are a closed book to most benefits and HR professionals.
Defined Benefit Plan Problems
Part of the problem with DB plans is that they were hard to understand. In employee meetings, my spiel was something like, “If you work for (insert company name here) for the next 25 years, you’ll get a monthly pension of some percentage of your average compensation; payable for your lifetime or 10 years, whichever is longer. Meanwhile, your current vested accrued pension is $28.73, up from $20.21 last year, which you will get when you turn 65. Have a nice day.” The benefit was so theoretical to the average employees that they had very little appreciation of it, at least until they were getting close to retirement age.
Another part of the problem was that the employer costs for the DB plans were hard to understand, partly because of the complex funding rules. Most clients had a current benefit cost and a cost for past benefits. Those past benefits were amortized over 10 to 30 years, so the client had a range of contributions he could make. Very seldom could I tell the client that his contribution requirement was X; I had to say that it was anywhere between X and Y, unless he wanted to change funding methods, in which case the answer might be Z.
Along Came the 401(k) Plan
To me, though, what really killed the DB plan was the 401(k) plan. 401(k) plans were originally conceived as a supplement to DB plans, but now they are the only retirement plan for a majority of the population. By contrast to DB plans, a 401(k) plan is easy to explain to both employers and employees. It takes the responsibility for the employee’s retirement away from the employer, and puts it on the employee. It can be shut down more easily than a DB plan can be unwound. When a participant wants a distribution, all that needs to happen is an account balance review, and his payout will be determined. No mess, no fuss.
But there was a time when DB plans ruled. A retirement target was created, and that target had to be hit. No one would outlive his pension, because his pension was guaranteed for life. The employer, not the employee, paid for the benefit. A retirement plan was for retirement; it was not used merely as a savings account, or as collateral for a new car loan. And the work to value an account was done once a year, not every day.
Thanks for letting me indulge in a trip down memory lane.