Traditional pension plans have not returned. But the IBM news might make us think so.
Last month, IBM unfrozen a defined benefit pension plan that had frozen more than 15 years back. The company also stopped making contributions to employees’ 401(k) accounts.
These moves are surprising because, at least on the surface, IBM appears to be reversing a decades-long trend of corporations moving away from traditional pension plans. Under the old plans, companies promised to pay employees retirement income that rewarded them for long years of service. But these plans were expensive, and IBM and hundreds of other companies began emphasizing 401(k) plans, which shifted the primary responsibility for saving and investing to workers.
IBM’s new approach is significant because the company has been a leader in formulating employee benefits policies. What it is doing now is not a simple return to the classic cradle-to-grave benefit system. In fact, IBM’s new pension plan is not as generous to long-serving employees compared to its predecessor.
The move has real advantages for some people who work at IBM, particularly those who put little or no money of their own into 401(k)s and who stay with the company for a relatively short time.
Fundamentally, IBM’s move will likely be wonderful for its shareholders. The company is saving hundreds of millions of dollars a year by stopping contributions to employees’ 401(k) accounts. And you don’t need to put money into the pension plan this year (and probably for years to come) because you already have a lot of money in it. From a purely financial standpoint, IBM is improving its cash flow and results.
For a small but important subset of companies — those with fully funded, closed or frozen pension plans — IBM’s move could be a harbinger of things to come, pension consultants say. IBM is using a surplus from its pension fund to simultaneously change its employee benefits package and help the company’s finances.
“You’ll see more of this,” said Matt Maloney, senior partner at Aon. “But I don’t think it’s really a milestone because not many companies are in a position to do what IBM is doing.”
Retirement Basics
IBM calls its new pension plan a “retirement benefit account.” It is nested, legally and bureaucratically, within the previous version. Because it is part of the defined benefit pension plan, the new plan is backed by the government Pension Benefit Guarantee Corporationthat will pay benefitsup to certain limits, if the plan runs out of money or the employer goes out of business.
Unlike 401(k)s, in pension plans the employer “makes the contribution, owns the assets, selects the investments and assumes the investment risk,” said Alicia Munnell, director of the Boston Retirement Research Center. College.
Employees immediately buy into IBM’s new plan and can take their money with them when they leave, IBM says. So far, so good.
But for many employees, the change comes at a cost.
IBM will no longer contribute to its employees’ 401(k) plans. Until now, it made 5 percent matching contributions and 1 percent automatic contributions, according to published internal documents. in public and whose authenticity was confirmed by Jessica Chen, IBM spokesperson. That money and those accounts are the property of the employees. It took a year for employees to qualify for those accounts.
The new retirement benefit accounts are part of a so-called cash balance plan, a pension plan in which the employer controls how the money is invested.
In IBM’s new accounts, employees receive credits equal to 5 percent of their salary, 1 percentage point less than the company’s maximum 401(k) contribution used to be. For the first year only, employees will receive a 1 percent pay increase to make up for the discrepancy in contributions between the old 401(k) and the new retirement accounts.
Risk and return
IBM documents show that on the new accounts, employees are guaranteed a 6 percent interest return for the first three years, an excellent rate under current market conditions.
Between 2027 and 2033, performance is likely to decline. Employees will receive the yield on 10-year Treasury bonds, with a minimum of 3 percent. From 2034 there is no floor. So if Treasury yields fall below 3 percent (as they did most of the time from late 2008 to early 2022), all employees will get is a paltry return.
Remember, in a 401(k), employees are free to invest however they want. People with a long-term investment horizon may prefer the stock market, which tends to produce higher returns than government bonds over long periods.
Although IBM workers can keep their 401(k)s and continue adding money to them, they won’t have the incentive of a company match. It remains to be seen how many will continue to contribute. In the new accounts, employees only receive fixed income investments.
That may be fine for retired people, but it’s questionable for those who will have many years in the workforce. Employees may need to increase equity allocations in their 401(k) or other accounts.
The bottom
In the heyday of defined benefit plans in the 1970s, up to 62 percent of private-sector workers were covered solely by these retirement plans, according to the Employee Benefit Research Institute, an independent organization that researches health issues. retirement.
By 2022, the institute foundjust 1 percent of private sector salaried workers had only a defined benefit plan, while 41 percent participated in only a defined contribution plan, or 401(k), and 8 percent participated in both.
The lack of funding for corporate pension plans led to a major shift away from defined benefit plans. Initially, 401(k)s were supplemental savings vehicles for employees. Now, along with Social Security, 401(k) plans have become central elements of retirement.
By closing old defined benefit plans to new workers and freezing benefits for people already enrolled in them, companies reduced their potential pension obligations. They poured money into old retirement plans to make them comply with government regulations, which were relaxed to give companies relief.
But astute management and cooperative financial markets have also helped boost funding for the plan. Since pensions are a form of annuities, rising interest rates in recent years have made it cheaper to finance existing pensions. On top of that, strong stock returns over the past decade have boosted the funds’ assets.
These factors have caused a radical change in the financing of old corporate pension plans. (Public pension plans, on the other hand, face a funding shortfall estimated at $1.45 trillion, according to the Pew Charitable Trusts.) For large companies, the average private defined benefit plan now has more than enough money to pay its pension obligations. For defined benefit pension plans at S&P 500 companies, Aon saysFunding levels increased to 102.7 percent on February 6 from 78.4 percent in 2011.
The bottom line
IBM’s defined benefit pension plan is now very well funded. Its annual report shows that it had a $3.5 billion surplus in the plan last year, while it paid out $550 million annually in 401(k) contributions. You don’t need to put any new money into the pension plan, and now, with the switch to new retirement benefit accounts, you don’t make 401(k) contributions either.
Professor Munnell estimated that IBM could credit employees with benefits in the new accounts for at least the next six or seven years. Several pension consultants said that if market conditions were favorable and IBM invested the $3.5 billion surplus at a higher rate of return than the fixed income rates it offered its employees, it could avoid using cash on these benefits for many years. .
The company said its retirement innovation was improving its finances. In an earnings conference call on Jan. 24, James J. Kavanaugh, IBM’s chief financial officer, said the company’s cash flow was better this year, in part due to “lower cash requirements driven by changes in our retirement plans. That could be true for years to come.
Other companies with frozen, fully funded plans could follow IBM’s lead.
This is not a return to the richer benefits for senior employees provided by traditional defined benefit plans.
But perhaps cash balance plans combined with 401(k)s are the best that most large companies are likely to offer. Then, Zorast Wadia, suggested a senior actuary and consultant at Milliman, the pension consultancy, there are a variety of ways to design retirement packages that make use of pension plan surpluses. Unlike IBM, for example, some companies could continue their 401(k) contributions while starting cash balance plans.
Finding ways to use well-funded pension plans generously but responsibly is a challenge for large companies. IBM has acted cautiously. But no one is interested in companies making pension promises that they cannot keep.
