In “Transitioning from a Defined Benefit to a Defined Contribution Program | Part II: The Migration Study,” Max Diaz of Cammack Retirement points out that while the shift from a DB plan to a DC plan may make the difference between no more retirement plan and having one, despite that obvious benefit to employees there are some employees for whom the shift may not be unqualified good news: those who are closer to retirement age.
Diaz observes that even freezing a DB plan doesn’t necessarily mean that spending on the plan stops. Freezing stops “ongoing benefit accruals and reduces future annual funding requirements,” he says, but at the very least a plan still will have to fully fund shortfalls that result from past benefit accruals. Not only that, if an employer has frozen its DB plan and is shifting to a DC plan, it also must start funding the DC plan.
But there could be still more, Diaz adds. The issue? Whether the plan will provide enhanced or supplemental contributions for “senior” employees.
Why Is this an Issue?
Diaz argues that shifting from a DB plan to a DC plan will not have the same effect on younger employees than it can on older employees. And younger employees can ameliorate the situation if the change is a move to a plan that is less generous, Diaz says: “even small changes in spending habits or a slight increase in their savings rate can make a large impact come retirement.”
But the same cannot be said of older employees, says Diaz, who argues that “older employees lack the time necessary to make up for their benefit losses and tend to be the most negatively impacted by moving away from DB-style plans.”
What to Do?
An employer can decide not to provide enhanced contributions to older employees, although decision carries its own possible consequences. If the employer decides that it will provide such contributions to that subset of employees, it must determine its ability to do so.
Diaz argues that providing enhanced contributions to older employees and augmenting their attempts to minimize the impact of the transition would be valuable to those employees. “Encouraging employee participation and increasing deferral amounts are essential to maximize successful retirement outcomes.”
What would it take? Diaz says it would “require a combination of targeted employee communications, automatic enrollment/escalation, and matching contribution plan design features on behalf of plan sponsors.”
He also suggests that a plan consider some questions before it embarks on such an effort:
1. What is the targeted long-term cost for the retirement program as a percentage of payroll?
2. What can the organization afford in the interim while funding both the DB and DC plans?
3. Are enhanced contributions a possibility?
The Bottom Line
Diaz reports that Cammack found that providing enhanced contributions to older employees does not enjoy widespread popularity among employers and providers, many of whom they find “are unwilling, at least initially, to budget more than the expected costs under their current DB program,” which he attributes to reasoning “linked to the lack of immediate savings.” He disputes that contention, however, arguing that “savings begin to mount as the DB plan shrinks over time and its funding level improves (requiring less in annual contributions).”
“For some employers, cutting costs is the only key factor, while other organizations may look to mitigate the impact of lost benefits to its older and longer-service employees,” says Diaz. “For most it is a delicate balance that also includes the potential impact to the balance sheet and employee demographic considerations, including retention and the ability to maintain a competitive benefit program,” he continues.
Budgets are a key considerations, according to Diaz. “It is a lot to juggle, which is why defining the budget comes first and everything else follows.” He also notes, “The long-term target budget provides the framework, but it is the short-term budget, along with the lost benefit analysis, that ultimately determines the structure of the final program.”