IBM Just Flipped the Script: Are Companies Now Going to Bring Back Pensions?

Defined-benefit pension plans have suddenly gained new support, with employers, unions, and benefits experts now talking up the pension model—which once was seen by many as relic of the past. Although defined-contribution plans have become the standard retirement benefit offered by most employers, recent events suggest that some may be taking a new look at defined-benefit pensions.

Forbes magazine announced a recent IBM decision to return to defined-benefit plans with prominent picture of a dinosaur. The Wall Street Journal published an opinion piece with the headline: “Bring Back Corporate Pension Plans. Seriously.” And Pensions and Investments asked: “Is renewed interest in DB plans real, or just a pipe dream?”

Perhaps more important, the demand for defined-benefit plans seems to have returned to major labor groups such as the United Auto Workers (UAW), which pushed hard to reinstate that model of pension plans for new workers with its latest contracts. That effort failed, but the UAW contracts do include increases in 401(k) contributions of the employees’ defined-contribution retirement benefits, and it is likely that the union will revisit the question at some point in the future.

The decision by IBM to switch to a “hybrid” model of defined-benefit plan means that the company will no longer match employee contributions to 401(k)s, but will instead offer a 5 percent retirement benefit via a defined-benefit plan—with employees guaranteed a 6 percent annual interest rate for the first three years. The Forbes article noted that IBM had led the way 15 years ago in leaving the defined-benefit pension model for the defined-contribution approach, leading to other industry giants to do the same.

“It’s pretty significant,” said Jared Gross, head of institutional portfolio strategy at J.P. Morgan Asset Management. “A lot of people have expressed skepticism that something like this could happen, but it does appear there’s a little bit of momentum behind it.”

Gross noted that IBM is redirecting the value of the 401(k) contributions to the defined-benefit pension plan, and that other adjustments are being made. “I think there are two really interesting things. … This is 180-degree change from the direction of travel that most corporate defined-benefit plans have been on. … It’s also a profound statement on the nature of matching contributions in DC plans.” Gross explained that 401(k) plans used to be offered on an opt-in basis—that is, the employee was not automatically enrolled. Today, many plans are opt-out—employees are enrolled automatically and have to actively choose to skip the benefit. In addition, the SECURE 2.0 law will require all defined-contribution retirement plans after 2025 to be opt-out, with auto-enrollment. It will also require employers to provide a level of matching funding.

The idea of matching funds from employers in a defined-contribution plan is no longer novel, Gross notes, and will eventually be universal. “The match was seen correctly as a powerful incentive to get people to sign up,” he said. “With opt-out [becoming the rule], that incentive is no longer necessary. What I think IBM is saying is that it’s going to be more be more cost-effective for them, and potentially more valuable to the participants, to obtain that value in the form of the defined benefit. I think that’s a pretty interesting change.”

In addition to the new regulatory environment, the investment world has seen recent changes, as rising interest rates have “opened up entirely new possibilities” for pensions, according to the Wall Street Journal article, which notes that many corporations had “frozen” defined-benefit pension accounts and put all their emphasis on defined-contribution plans for new employees.

Gross and other experts point out that there are upsides and downsides to both defined-benefit and defined-contribution models. “Neither one can offer everything you want,” he said. “The optimal way to deliver retirement benefits to plan participants is to have both the DB and the DC.”

Dan Doonan, executive director of the National Institute on Retirement Security, agreed that both defined-contribution and defined-benefit plans are evolving. “There is a ton of customization possible on the DB side,” he said of current offerings. He noted the defined-benefit pension model has gained a reputation for not being able to control risk and, therefore, costs. But the defined-contribution model of retirement accounts could be seen as shifting more risk and uncertainty onto plan members, who in some cases are now pushing for more security and predictability in their retirement plans.

“I think that both the DC and DB industries are trying to change themselves in a way where they keep their strengths and mitigate their soft spots,” he said. “On the DC side, the ability to control costs is a draw for employers, but at the same time, there’s more and more conversation about life income in DC plans; that’s something that’s really a challenge.”

Evolving Technology Leads to Evolving Retirement Plan Options

Doonan goes back in history to explain the evolution: “There has been a conventional wisdom out there that employers should avoid DB plans,” he said. “When you look back to the 70s, we were doing evaluations with paper and pencil. We didn’t have great tools to foresee what was coming. It was really difficult back then to do a great job of forecasting.”

That has changed, he added. “You see much better capabilities with the technology now,” he said. “In a lot of ways, as all these technologies evolved, we have a wider range of plan designs, where risk is more balanced.”

The biggest challenge may be in changing the attitudes of business owners and investment experts. Doonan noted that the tight labor market may prompt some to re-think their attitudes about defined-benefit pensions. “Business schools have been saying ‘Don’t offer a pension’ for a long time,” he said. “I don’t think firms have even been doing the analysis and really considering it in recent years. But that may change if the frustration with turnover continues.”

He added that one area which has stuck with defined-benefit pensions is the public sector, and he noted that public sector workers may stay with the same employer for decades. “There’s a culture of careers, not jobs. If the tight labor markets stick around, I think this will be an attractive option.”

“There has been a narrative for a long time that workers don’t appreciate DB plans,” Gross said. “The UAW negotiating position is a data point that suggests otherwise. The UAW wanted to restore the defined-benefit plans, and I think that they will ask for that again in the future.”

Doonan noted that there is an equity angle to pensions as well. “As we’ve seen the decline in pension coverage, we’ve seen a huge increase in inequality. Other than your home, retirement assets are one of the major assets that families have,” he said. “We did some research, and amongst retirees who don’t have a four-year degree but have a pension, they usually have a couple hundred thousand dollars of value there. That can really go a long way to top off Social Security and keep people out of poverty.”

From: BenefitsPRO