Now Is The Time To Re-Think Retirement Plan Design

The design of a retirement plan can make or break an employee’s capacity to maintain their level of living after retirement… [+].
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The design of a retirement plan can make or break an employee’s capacity to sustain their lifestyle in retirement. Many private-sector employers have redesigned their retirement plans in recent decades, moving away from defined benefit pensions and toward 401(k)-style defined contribution arrangements. 401(k) plans, which were originally intended to augment rather than replace pensions, have become the major employer-sponsored plan for many American workers. This shift necessitated the sacrifice of a number of significant pension plan elements as well as cost efficiency. Lifetime income, longevity risk pooling, required membership, pooled investments managed by professionals, disability and survivor protections, and targeted income replacement are all features specific to pensions that improve retirement security. Because of these intrinsic benefits, pensions can provide roughly double the retirement benefits at the same cost as a 401(k)-style defined contribution plan.

Individual… [+] defined contribution accounts are much less cost-effective than pensions for delivering retirement income. Pensions give the same retirement income at a 48 percent lower cost than 401(k)-style defined contribution (DC) funds due to the economic efficiencies contained in these retirement plans.
“It’s Still a Better Bang for the Buck,” says the author. The National Institute on Retirement Security (NIRS) is a non-profit organization

As a result of the move from pensions to 401(k) accounts, an increasing number of Americans are falling behind in saving enough money on their own to assure a secure retirement. Even if they work until they are 65 and annuitize all of their financial assets, half of today’s households will not have adequate retirement income to sustain their pre-retirement quality of life, according to the Boston College Center for Retirement Research. Americans are also aware of their perilous retirement situation. According to a recent national study, more than two-thirds of Americans (67%) believe the country is facing a retirement problem, and 68 percent believe the ordinary worker cannot save enough on their own to ensure a safe retirement.
Companies frequently cited financial risk as the rationale for the drastic change in perk structure. Unfortunately, transferring employees from pensions to individual 401(k) plans shifted risks and expenses to individuals who often lack access to the professional expertise provided by pension systems.
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Private sector employers, however, were still required to pay accrued benefits even after closing a pension plan and ceasing future accruals, implying that employers must manage legacy benefits in pension plans with greater negative cashflows over time, making it more difficult to recover from down markets.
State and local governments, in contrast to private sector employers, have taken a distinct approach to retirement plan design. In many cases, state and local governments chose a long-term approach to retirement plan design, balancing employee retirement needs with risk mitigation, cost management, and perks that will attract and keep competent workers to provide critical taxpayer services.
As a result, nearly all state and municipal companies continue to offer pensions as their primary retirement plan, with some adding supplemental defined contribution plans as well. To address specific concerns or fulfill workforce goals, several state and municipal companies have tweaked their retirement offerings.

In the public sector, pensions are more commonly offered than in the private sector.
The National Institute on Retirement Security (NIRS) is a non-profit organization
Defined benefit plans are governed by a regulatory structure that provides for a wide range of plan types. South Dakota’s public employee retirement system, for example, has kept pension expenses consistent for decades. By permitting even non-vested members to leave contributions in the system through retirement (preventing leakage) and offering annuitization at retirement, Colorado PERA delivers strong retirement benefits for younger, less tenured workers than pensions normally do. As a result, workers can continue to count on a steady stream of retirement income. Meanwhile, governmental companies in both Colorado and South Dakota benefit from strong retirement benefits, which have been shown to be an effective strategy for attracting and retaining employees.
In fact, a recent paper from the actuarial company Chieron and the National Institute on Retirement Security gives a thorough analysis of the many components of hybrid retirement plan designs in the public sector. Many of these non-standard plan design aspects have been employed to tailor their benefit offers, according to the Hybrid Handbook.
Looking back, it’s a shame that more private firms didn’t try to be more innovative within the pension framework when redesigning their retirement plans. Their current employees would be better positioned for the same degree of retirement security as today’s seniors if they had kept a modified pension plan. Employers would also have avoided the challenges of operating a closed pension plan, such as aging demographics and huge negative cashflows, which are difficult to manage in turbulent investment markets. As a result, inefficiencies emerge on both sides: corporations incur significant costs to pay for their legacy pension schemes with costly annuity purchases, while employees are unable to receive life income in a cost-effective manner.
There may be a win-win solution. For younger generations, the retirement dilemma is becoming increasingly challenging. At the same time, many firms in the United States are having trouble finding and keeping suitable employees. Employers who offer pensions have a proven method of attracting and retaining competent employees. Pensions, in fact, are seen favorably by Americans, who consider them to be superior to 401(k) funds. Seventy-six percent of Americans think defined benefit pensions are a good idea, and 65 percent think pensions are better than 401(k) plans for retirement security.
Now might be a good time for private-sector employers with closed pension plans to reconsider their retirement plan design options. Instead of purchasing pricey annuities, which are rendered even more expensive by historically low interest rates, there may be methods to restructure their retirement plan offerings to fit both business and employee objectives./nRead More