Honey, I Shrunk the 401(k)

The bear market has clobbered 401(k) accounts, and it could spark a revival of defined benefit plans.

That rumbling sound you hear in the distance is the growing chorus of very disgruntled employees who now realize that 401(k) account balances can shrink as well as grow — and who have discovered that they’re not very good at managing them, anyway. They’re calling for a return of the old-fashioned defined benefit plan, or for one of the new pension hybrids that meld features of defined benefit and defined contribution plans.

According to Principal Financial Group’s Well-Being Index, a snapshot of employee attitudes about benefits, 24 percent of employees want access to a defined benefit plan, up from 19 percent just a year ago. Surprisingly, some of them may soon get their way. Companies are beginning to reevaluate defined benefit plans, and some are actually implementing them or hybrid plans. The state of Nebraska, for one, recently installed a brand-new hybrid plan for some of its employees.

One Boston-based actuarial consultant, Edward Burrows, reports a recent uptick in new defined benefit plans at small professional-services firms, such as law, consulting, and accounting practices. Small companies have typically shied away from defined benefit plans because of the ongoing financial liability they represent. But the recent relaxation of statutory limits on maximum benefits and contributions for “top heavy” pension plans — and the undoubtedly shrinking 401(k) plans of the owners themselves — are paving the way for companies to adopt them.

But defined benefit and hybrid pension plans face a slew of roadblocks — some old, some new — that could make them difficult for employers to implement or upgrade. Still, businesses large and small feel pressure to do something to provide stable retirement income for their employees, and to do it now.

“They Just Let Them Go”

Until 1981, when the Internal Revenue Service gave provisional approval to the first 401(k) plan, defined benefit plans were more often than not the only retirement plan available (except for Social Security). But once the 401(k) was hatched, defined benefit plans began to fall out of favor. In lieu of perpetual funding concerns, high administrative costs, and annual premiums to the Pension Benefit Guaranty Corp., a 401(k) plan offered optional employer matching, low administrative costs, and no premiums. Employees lost a guaranteed (albeit fixed) retirement benefit, but gained portability and the prospect of hefty stock-market gains.

As 401(k)s became more popular — the number of participants swelled from 7 million in 1983 to 42.1 million in 2000 — the fledgling high-tech and services businesses of the New Economy didn’t even bother setting up defined benefit plans, using 401(k)s as the primary employee retirement vehicle. The defined benefit plan seemed slated for extinction — an expensive encumbrance of Old Economy companies, at which workers often spent their entire careers.

Indeed, a recent study shows that “once a company installs a 401(k) plan, they just let their [traditional] pension plans deteriorate,” says Teresa Ghilarducci, associate professor of economics at the University of Notre Dame and lead author of the study. “They don’t enhance the pension benefits, they don’t adjust for inflation. They don’t aggressively manage them. They just let them go.” Even if a company keeps its defined benefit plan, a 401(k) plan has the effect of reducing the total amount of money per employee that employers contribute annually anywhere from 14 percent to 22 percent, according to Ghilarducci’s study.


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