The DB(k): Pension of the Future

When hiring picks up again, this blend of defined benefit and 401(k) features will help snag top talent.

By Joan Pryde, Senior Tax Editor, the Kiplinger letters

August 19, 2009

An attractive new option for employer sponsored retirement plans becomes available next year. The “DB(k)” offers businesses with 500 or fewer employees an opportunity to provide a strong retirement plan for their employees with fewer hassles and less financial drain than a traditional pension plan.

The DB(k) melds a 401(k) savings plan with a small guaranteed income stream. “You take the best of the defined benefit concept and put it together with a 401(k) plan,” says Lynn Dudley, senior vice president for policy with the American Benefits Council. The key elements of the plan:

• A defined benefit equal to 1% of final average pay for each year of the employee’s service, up to 20 years.

• An automatic enrollment feature for the 401(k) portion. Unless an employee specifically opts out or changes the contribution level, 4% of pay is automatically shunted into 401(k) savings.

• An employer match of at least 50% of employee 401(k) contributions, with a maximum required match of 2% of pay.

To induce employers to participate: An exemption from “top-heavy” rules, which are used to ensure that a company’s retirement plans are not unfairly skewed toward high paid workers. In addition, the paperwork burden is much lighter for a DB(k) plan than if a company operates separate pension and 401(k) plans, says Martella Turner-Joseph, a pension actuary and a member of the board of the American Society of Pension Professionals & Actuaries. With the DB(k), a company need have only one plan document and file one Form 5500 -- the annual information return for benefit plans -- even though it is essentially operating two plans.

The DB(k), authorized by Congress as part of the 2006 Pension Protection Act, is designed to repair a flaw in the current retirement system. The 401(k), originally conceived as a supplement to employer paid pensions, has become many people’s primary source of retirement income. But even before the stock market slide of late 2008 and early 2009, there were fears that, for many workers, voluntary savings would prove woefully inadequate in retirement. Indeed, for a majority of workers with no pension plan, the lump sum 401(k) distribution they receive at retirement, even if managed well, may not last. So Washington policymakers set out to encourage a comeback in pensions, albeit much smaller pensions than in the past. The much more limited size is intended to ensure that employers won’t find their plan in need of considerable new funds, as so many pension plan sponsors have in the past several years.

While the economy continues to struggle, interest in DB(k)s will be light. With an unemployment rate soaring toward 10%, there’ll be no swell of companies rushing to adopt DB(k)s come Jan. 1, 2010, when the gate opens. But we expect the concept to pick up steam as the economy strengthens and competition for good workers again becomes keen. Indeed, there is already discussion among pension industry officials about pushing Congress to make DB(k)s available to larger companies, too.

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