Why Do Companies Keep Traditional Pension Plans?

Only 20% of companies maintain traditional defined benefit pension plans (“DB Plans”). More than 40% of companies provided these DB plans 20 years ago. Outlined below are the main reasons why companies continue to sponsor these plans at all:

1. DB Plans are the best retirement plan for employees. Employers who really care about their employees will want them to retire after a long career with retirement benefits that replace a substantial percentage of their income. DB Plans are almost always fully funded by the employer, without investment risk to the employee and provide monthly benefits that are paid for the life of the employee. The typical 401(k) plans that have replaced DB Plans are almost the complete opposite. They shift the investment and longevity risks from the employer to the employee, require significant employee contributions to receive employer contributions and provide benefits that hard to predict.

2. Employers want job opportunities for young, talented employees. DB Plans provide adequate retirement income for older, career workers so they can voluntarily retire. These retirements provide promotion or recruitment opportunities for young and, usually, more technologically advanced workers. As currently being experienced, few career employees with 401(k) plans can afford to retire. Because the Age Discrimination in Employment Act (ADEA) forbids age discrimination against people who are age 40 or older, employers find it hard to document performance issues that will allow them to terminate the employment of older workers.

3. Employers can use surplus DB Plan assets. When DB Plan assets exceed plan liabilities, companies can reduce or eliminate DB Plan contributions until this “surplus” is used up. This cash flow savings can go on for many years. If a DB Plan is terminated with “surplus” assets, a 50% excise tax would be applied. The excise tax is reduced to 25%, if 20% of surplus assets are transferred to another qualified replacement plan. Many companies who want to terminate their DB Plan, use up all surplus assets in the DB Plan to avoid any excise tax.

4. Employers have to continue DB Plan contributions. While a company is financially viable, it must continue to fund its DB Plan at least until assets are sufficient to settle all plan liabilities. These companies that want to terminate their DB Plan usually “freeze” the plan so that employees accrue no more benefits. It can take many years for these employers before they can buy annuities and/or pay lump distributions in accordance with government regulations. Only at that time can the DB Plan be terminated.

Employers that are continuing their DB Plans for the first two reasons described above may do so forever. These employers realize that DB Plans provide the results that were promised when these DB Plans were adopted. They now also see the problems that 401(k) plans have.

Employers that are continuing their DB Plans for the last two reasons described above will eventually terminate their DB Plans.