Shifting the 401(k) ‘Balance’

Recently, I came across an announcement that IBM was making changes to its 401(k).

More specifically that, effective next year they were going to replace their matching contribution in their 401(k) with an employer contribution to a cash balance plan.[1] In the days that followed, the news was picked up in a couple of different trade publications—the implication being that this might be signs of a new shift in plan design. Heck, even Teresa Ghilarducci weighed in, championing the “evolution” to a defined benefit structure from the “flawed” 401(k). She never misses an “opportunity.”

Readers here are likely familiar with the basic concepts of a cash balance design. Technically a DB plan, it’s generally referred to as a “hybrid” because it also has a number of participant-friendly aspects that it shares with a defined contribution plan, notably an account balance (though it’s a “notional” one) that is shared with participants. The benefits accumulate somewhat evenly over time, rather than being more service “back-loaded” as traditional pension plans tend to be. But just like a traditional DB plan, cash balance plans are funded by the employer on an actuarial basis, and the investments are employer-directed, ostensibly with an eye toward the benefit obligations that are accruing. Also, some cash balance plans are insured by the Pension Benefit Guaranty Corporation (PBGC), just like traditional pensions (and yes, the employer has to pay premiums).

Of course, cash balance designs aren’t new, nor are they new at IBM, which (in)famously shifted to one from a traditional defined benefit plan back in the late 1990s. I say “infamously” because it triggered a couple of participant lawsuits from individuals who thought their benefits had been reduced in the move—an age discrimination suit they won, only to lose on appeal. That said, even in finding for IBM the appellate court acknowledged that older workers were generally correct in perceiving "that they are worse off under a cash-balance approach" because such a plan eliminated the possibility of earning larger benefits as they neared retirement. "But removing a feature that gave extra benefits to the old differs from discriminating against them," the judge wrote. 

That controversy notwithstanding, cash balance plans have, in recent years, proven to be quite popular—particularly among smaller employers because they provide more funding flexibility than a traditional DB plan, and the potential for better benefit accumulation than the non-discrimination and top-heavy test limits often allow with defined contribution plans, such as a 401(k). But what IBM has done—basically replacing its 401(k) match with a cash balance plan contribution—does appear to be unique, and worth noting.

As for IBM, while external perspectives on the announcement appear to be largely positive,[2] it remains to be seen how it will be accepted by those it is ostensibly designed to benefit. Some have already commented that the loss of a match will reduce incentives to save in the 401(k)—others that the resulting diminishment in the 401(k) balance will undermine the amounts available for loans and hardships, though that arguably isn’t the purpose for those 401(k) savings, either. On the other hand, all eligible IBM employees stand to get this employer contribution, not just those who contribute to the 401(k) (though with what is said to be a 97% participation rate, it seems that few are left out at present, though we don’t know their contribution rates).

You don’t have to be a cynic (though it helps) to imagine that IBM has done the math here, and that the change is either neutral, or inures favorably to their bottom line.

People tend to forget that the contributions defined in a defined contribution plan can be (re)defined each plan year—and while reductions are rare, they are not unprecedented. That said, even in rolling this new benefit out, IBM has (according to an internal communication memo posted online) acknowledged a reduction; “IBMers will also receive a one-time salary increase to offset the difference between the IBM contributions they are currently eligible to receive in the 401(k) Plan and the new 5% RBA pay credit”—though arguably that’s trading a pre-tax benefit for one on which taxes will be due immediately.   

While it’s certainly an interesting move—by a company with a history of interesting benefit moves—and, despite the enthusiastic response of Professor Ghilarducci, it seems unlikely to catch on more broadly.  Retirement savers have not only long understood and appreciated not only the value of an employer match, and so seem unlikely to embrace “losing” that to new plan they don’t understand, however even the tradeoffs are presented. As for plan sponsors—well, inertia is a powerful force in plan design as well—and a big design change that requires sensitive (and likely) ongoing communication will almost surely give pause to even the most innovative.

That said, it should serve as a reminder that plan designs can, and should, serve multiple purposes. It will be interesting to see how this one pans out.

Footnotes

[1] It’s actually referred to as a Retirement Benefit Account (RBA), though the description fits a cash balance plan, and it’s described as being offered “within IBM’s Personal Pension Plan.”

[2] Not exclusively, of course—there’s cynicism to be found with regard to IBM’s true motives here.