BI’s Article search uses Boolean search capabilities. If you are not familiar with these principles, here are some quick tips.

To search specifically for more than one word, put the search term in quotation marks. For example, “workers compensation”. This will limit your search to that combination of words.

To search for a combination of terms, use quotations and the & symbol. For example, “hurricane” & “loss”.

Login Register Subscribe

Pension law may actually boost defined benefit plans

Pension law may actually boost defined benefit plans

Several months after President Bush signed into law the most sweeping pension reform legislation passed in more than 30 years, the jury is still out on what changes the measure will bring for U.S. workers and their employers.

But one thing is clear: Initial concern that the new law was uniformly negative for defined benefit pension plans was off base. With improved funding provisions and more plan design options, the Pension Protection Act may actually lead companies and their workers back to defined benefit pension plans.

The new law takes a number of steps that are likely to make good on the bill sponsors' promise of improving retirement security for millions of Americans. Most well-known are provisions that require better, more consistent funding of defined benefit pension plans. But other, lesser-known provisions in the act could have as much impact. Companies will be allowed to make higher tax-deductible contributions to their pension plans and, in many cases, will be given a longer period of time to make up any funding shortfalls. This allows employers to put more money into their plans when times are good and profits are high, and it also allows more time to fund the plan when times are tough.

As a recent Watson Wyatt Worldwide analysis confirms, the changes reduce the volatility of the minimum amount companies are required to contribute to their pension plans. In particular, they reduce the likelihood of sudden large spikes in required contributions, such as was experienced by many plan sponsors earlier this decade when interest rates declined and asset values dropped.

The new law also helps reduce the risk of pension defaults by restricting benefit increases and placing other constraints on poorly funded plans. That will reduce the exposure of the Pension Benefit Guaranty Corp. to future big losses. And that can only be good for defined benefit plan sponsors paying PBGC premiums as well as their employees and retirees.

In addition, the law, combined with recent federal court decisions, allow companies to reconsider a once-popular option many had put on hold due to past regulatory uncertainty—hybrid plans, such as cash balance plans. These plans can offer the best of both worlds—the security of a company-backed pension with the portability of a 401(k) plan. We are already beginning to see companies seriously consider these plans.

All of these changes make defined benefit plans more attractive, but it is unclear if the new law will be as supportive of defined contribution plans, such as 401(k)s.

Defined contribution plans largely shift the risks of financing retirement from employers to employees by requiring employees to contribute toward the cost of benefits and to experience directly the consequences of investment decisions. These plans are sometimes underused by employees who do not enroll in the plans or do not make contributions or investment choices sufficient to fund their retirement. The law's efforts to remedy that—by making it easier for employers to automatically enroll employees in these plans—will increase the cost and administrative burden of defined contribution plans for many employers. Simply increasing the number of participants in a plan means the employer has to manage the administration around more loans, hardship withdrawals and cash-outs, small accounts and turnover. Given these added burdens, it is unclear whether companies will opt to cover more of their workers with this automatic enrollment option.

Even if more employees are enrolled in defined contribution plans, research shows that such plans alone will not consistently meet employees' long-term retirement needs. For decades, employers have turned to defined benefit pension plans to manage their workforces, ensuring workers will be financially able to retire when their most productive years have passed. The Pension Protection Act gives employers a more supportive environment in which to provide such security. And that is certainly a step in the right direction.

Mark Warshawsky is director of retirement research at Watson Wyatt Worldwide in Arlington, Va. Before joining Watson Wyatt last August, Mr. Warshawsky was assistant secretary for economic policy at the U.S. Treasury Department.