Traditional pension plans have not returned. But news from IBM might lead you to think so.
Last month, IBM unfroze a defined benefit pension plan that it had frozen more than 15 years august. The company also stopped making contributions to employees’ 401(k) accounts.
These developments are surprising because, on the surface at least, IBM appears to be reversing a decades-long trend that sees companies moving away from traditional pension plans. With the old plans, companies promised to pay their employees a retirement income that would reward their long years of service. But those plans were expensive, and IBM and hundreds of other companies instead began emphasizing 401(k)s that shifted primary responsibility for saving and investing to workers.
IBM’s new approach is important because the company is a leader in developing employee benefits policies. What he is doing today is not a simple return to the classic cradle-to-grave welfare system. In fact, IBM’s new pension plan is nowhere near as generous to longtime employees as its predecessor.
The move has real benefits for some people who work at IBM, especially those who invest little or no money in 401(k)s and stay with the company for a relatively short period of time.
Above all, IBM’s maneuver risks being beneficial for its shareholders. The company saves hundreds of millions of dollars a year by stopping contributions to employee 401(k) accounts. And he doesn’t need to invest in the retirement plan this year – and probably for years to come – because he already has plenty of money. From a purely financial point of view, IBM is improving its cash flow and results.
For a small but important subset of companies — those whose pension plans are fully funded, closed or frozen — IBM’s move could be a harbinger of things to come, retirement consultants say. IBM is using a surplus in its pension fund to simultaneously change its benefits package and improve the company’s finances.
“You’ll see more of this stuff,” said Matt Maloney, senior partner at Aon. “But I don’t think it’s really a watershed event because not many companies can do what IBM is doing.”
IBM calls its new retirement plan a “retirement account.” It is nested, legally and bureaucratically, in the old version. Since it is part of the defined benefit pension plan, the new plan is supported by the government Retirement Benefits Guarantee CorporationWho go pay benefitsup to certain limits, if the plan runs out of money or the employer goes bankrupt.
Unlike 401(k) plans, in retirement plans the employer makes “the contribution, owns the assets, selects the investments and bears the investment risk,” said Alicia Munnell, director of the Center for Retirement Research at Boston College.
Employees benefit immediately from the new IBM plan and can take their money with them when they leave the company, IBM says. So far, so good.
But for many employees, this change comes at a cost.
IBM will no longer make contributions to employee 401(k) plans. Until now, it paid 5 percent matching contributions and 1 percent automatic contributions, according to published internal documents. publicly and whose authenticity Jessica Chen, an IBM defendant, confirmed. This money and these accounts belong to the employees. It took a year for employees to be invested in these accounts.
The new retirement accounts are part of a so-called cash balance plan, a retirement plan in which the employer controls how the money is invested.
In the new IBM accounts, employees receive credits equal to 5 percent of their salary, which is 1 percentage point less than the company’s maximum 401(k) contribution of yesteryear. For the first year only, employees receive a 1 percent pay increase to make up for the difference in contributions between the old 401(k) and the new retirement accounts.
Risk and return
IBM documents show that on new accounts, employees are guaranteed a 6% interest return for the first three years – an excellent rate in current market conditions.
From 2027 to 2033, the return risks failing. Employees will receive the yield on 10-year Treasury bonds, with a floor of 3 percent. From 2034, there is no longer a floor. So if Treasury yields fall below 3% — as they did most of the time between late 2008 and early 2022 — a paltry return will be all employees get.
Remember, in a 401(k), employees are free to invest however they want. People with a long-term investment horizon may favor the stock market, which tends to produce higher returns than government bonds over long periods of time.
Although IBM employees can keep their 401(k)s and continue adding money to them, they won’t have the benefit of a match from the company. It remains to be seen how many will continue to contribute. In the new accounts, employees only receive fixed-income investments.
This may be fine for retired people, but it’s questionable for those who still have years to come in the workforce. Employees may need to increase stock allocations in their 401(k) or other accounts.
At the height of defined benefit plans in the 1970s, as many as 62 percent of private-sector workers were covered solely by these pension plans, according to the Employee Benefit Research Institute, an independent organization that studies pension issues. retirement.
By 2022, the institute foundOnly 1 percent of private sector employees had only a defined benefit plan, while 41 percent participated only in a defined contribution plan – or 401(k) – and 8 percent participated in both.
The underfunding of company pension schemes has led to a mass abandonment of defined benefit schemes. Initially, 401(k)s were supplemental savings vehicles for employees. Now, with Social Security, 401(k)s have become an essential part of retirement.
By closing old defined benefit plans to new workers and freezing benefits for people already enrolled in those plans, companies have reduced their potential pension liabilities. They pumped money into old pension plans to bring them into line with government rules, relaxed to give businesses relief.
But wise management and cooperative financial markets have also helped increase plan funding. Pensions being a form of annuity, the rise in interest rates in recent years has meant that it cheaper to finance existing pensions. Additionally, strong stock market returns over the past decade have strengthened fund assets.
These factors have led to a sea change in the funding of legacy company pension plans. (Public pension plans, on the other hand, face an estimated $1.45 trillion funding gap, according to the Pew Charitable Trusts.) For large companies, the average private defined benefit plan now has enough money to pay its pension obligations. For defined benefit pension plans of S&P 500 companies, Aon saysFunding levels increased to 102.7 percent on February 6 from 78.4 percent in 2011.
IBM’s defined benefit pension plan is now extremely well funded. Its annual report shows it had a $3.5 billion surplus in the plan last year, even though it made $550 million a year in 401(k) contributions. He doesn’t need to put any new money into the retirement plan and now, with the switch to the new retirement accounts, he’s no longer making 401(k) contributions.
Professor Munnell estimated that IBM would be able to credit its employees with benefits in the new accounts for at least the next six or seven years. Several retirement 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, she might be able to avoid spending money on these fringe benefits for many years. .
The company said its retirement innovation improved its finances. In a Jan. 24 earnings conference call, 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 due to changes to our retirement plans.” This could be true for years to come.
Other companies with frozen and fully capitalized plans could follow IBM’s lead.
This is not a return to the richer benefits offered to long-tenured employees 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. If applicable, Oued Zorast, senior actuary and consultant at Milliman, the retirement consultant, suggested that there are a variety of ways to design retirement programs that utilize 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 retirement plans generously but responsibly is a challenge for large companies. IBM moved cautiously. But it’s in no one’s interest for companies to make retirement promises they can’t keep.