Is IBM on to something?
Big Blue recently announced that they would end the company’s 401(k) match effective January 1, 2024, replacing it with a Retirement Benefit Account (RBA). It will replace the match with a fixed employer contribution of 5% of compensation plus a one-time 1% pay increase. The pay credits will accumulate interest at an initial rate of 6% for the first three years and afterward tied to Treasury rates with a floor of 3% for the first seven years.
While IBM has not publicly announced the reasons for this decision, anecdotal evidence shows they are aware of shifting employee demographics and preferences and the need to balance those demands with an employee’s current income needs. It creates a shift back to pension-style arrangements, usurping defined contribution plans, i.e., 401(k) and profit-sharing plans.
Stepping back for a moment to review the mounting evidence of employee preference shows IBM is indeed on to something after all.
Research published by the Pew Charitable Trust identified that only 10% of workers prefer a lump sum payment at retirement; a study by the National Institute for Retirement Security has calculated that achieving retirement readiness success costs 46% less in a defined benefit plan, and a recent article in the New York Times pointed to the trend that younger workers prefer a pension style arrangement over traditional defined contribution plans. Furthermore, employees are more likely to stay in their current jobs if a pension plan is included in their benefit package.
IBM may be the one making headlines, but they are not alone in the quest to control costs and deliver on employee preferences. Another example is the Wisconsin Retirement System. Their arrangement provides the greater of a pension benefit formula or a Money Purchase Plan account balance; or should we say a floor-offset plan?
The rise in popularity of these arrangements may show the challenges participants face in achieving retirement readiness in traditional defined contribution plans. They are tasked with determining how much they need to save, making investment decisions, and how to structure distributions during retirement. Compared to a pension with a stated benefit payment at retirement, it’s easy to understand an employee’s preference.
From the employer’s perspective, a 5% pay credit and long-term interest credits of 5.2% (historical average return on 20-year government bonds) will replace, on average, approximately 58% of an employee’s pay at retirement. For lower-paid workers (those below $90,000), the replacement ratio climbs to 80% with no employee contribution. That makes a compelling recruitment argument.
So, where are we headed? It’s hard to say, but it’s important not to ignore the trends and focus on what the data and research tell us. This means it’s incumbent on practitioners (advisors, TPAs, etc.) to build multi-strategy solutions that address employer and participant concerns. To illustrate how this is achievable, we start with the client defining a career average target benefit for their employees at retirement. The target benefit may vary across groups of employees. Applying the principal concepts employed by IBM and the Wisconsin Retirement System, what rate of pay should the employer make to each target benefit group? This defines the participant’s Retirement Benefit Account (RBA).
To support the RBA, the plan may use various combinations of a cash balance, profit-sharing, money purchase, or 401(k) plan with an employer match. The employer funds the employee’s average career target benefit through this arrangement. The employee can use the 401(k) plan to close any funding gaps created by a lack of savings in the past or to enhance their target benefits at retirement.
The result is a focus on retirement readiness, improved outcomes for lower-paid employees and allowing them to create generational wealth, and a competitive benefits package progressive employers can use to attract and retain key talent. Isn’t that what it is all about?
Richard Phillips, EA, AIFA, CPC, CPFA, QPA, QKA is Chief Executive Officer of Brentwood, Tenn.-based ERISA Consultants.
