SANTA ANA, Calif.—Orange County, Calif., has adopted a novel retirement plan in which new union employees can choose between participating only in the $4.7 billion defined benefit plan, or participating in both the DB and a new defined contribution plan.

Those choosing the combination pay a lower contribution to the defined benefit plan, but also get reduced benefits. On the DC side, they get a small employer match.

The Orange County Employees Retirement System in Santa Ana, Calif., administers the plan, but the new approach was developed by executives of the union—the Orange County Employees Assn.—and management.

Officials from both sides say the new design will reduce the county's defined benefit plan expenses.

William Campbell, vice chairman of the Orange County Board of Supervisors in Santa Ana, said an actuary hired by the county calculated the new plan could cut annual costs by about 2% over time, assuming half of new employees choose the combination of a DB and a DC plan.

Keith Brainard, research director for the National Assn. of State Retirement Administrators in Baton Rouge, La., noted that plans with a defined contribution component “present lower long-term liabilities for the employer.” The problem, however, is usage. Mr. Brainard said he believes most new employees select traditional DB plans over other types.

The new plan is unique to California, and required passage of legislation last year to authorize it. The county and the union agreed to the plan in June 2009; enrollment began last month.

Neither Mr. Campbell nor Lisa Major, assistant general manager for the union, could recall who made the first move toward proposing the new approach when union and county negotiators starting discussing a new contract in the spring of 2009.

“It seemed like we came to it at about the same time,” Ms. Major said.

“It was both of us,” said Mr. Campbell. “We wanted to reduce the (DB) plan for new employees. The union wanted to give new employees a choice.”

The defined contribution portion was developed and will be administered by New York-based TIAA-CREF.

The DC component “works in tandem with, rather than supplements,” the defined benefit plan, said Richard Hiller, vp for government and religious markets at TIAA-CREF. “The overall pension plan is structured to help employees replace 70% or more of their income in retirement. The DB (formula) doesn't accomplish that on its own, so the DC plan is layered on to help achieve the necessary income in retirement.”

The standard employer match is 50% on up to 2% of pay contributed by an employee. In the plan's first year of operation, however, the match is 100% on up to 2% of the employee contribution.

On the defined benefit side, those choosing to enroll in the DC plan will make a smaller contribution to the DB plan. In exchange, the benefit payment will be less. In addition, they must work until age 65 to get their full benefit payment. Those sticking with the original DB-only approach may retire with full benefits at 55.

Mr. Campbell said that change also benefits the county because “the county can retain employees 10 years longer and thereby reduce costs associated with training and recruitment.”

Costs could be reduced further if existing employees are given the same choices that new employees get, something both the county and the union support. So far, however, that move has been blocked by the Internal Revenue Service.

“Mandatory employee contributions to public employee retirement plans are considered "picked up' employer contributions for federal income tax purposes,” said Mr. Campbell. “The employee is not taxed when the contributions are made, but is taxed on the benefits when (they) are received.”

The IRS is questioning if allowing current employees a one-time chance to switch to the new plan “will cause their contributions to lose their pretax status and whether this loss will apply to all...current employees...including those who do not elect the lower formula,” he said.

Mr. Campbell said the county has been discussing this issue with the IRS since September 2009. He hopes for a ruling later this year.

The new structure reflects employees' evolving attitudes about work and retirement, Ms. Major said. “If I'm 25, I don't know if I'll be working in the same place until I'm 55,” she said. “People move around a lot more. A defined benefit plan is the most reliable (retirement investment), but some people want more control over their money” through a defined contribution plan.

Robert Steyer is a reporter at Pensions & Investments, a sister publication of Business Insurance.