Saturday, April 28, 2007

The Deification of DB-ification

Last week, I stumbled across another of those “DC plans are becoming like DB plans” articles—you know, the “DB-ification” of 401(k)s?

This is all supposed to be a good thing, of course, because we know that defined benefit plans do a better job of providing adequate income in retirement than defined contribution plans (well, properly funded, and when workers accumulate adequate service credits, anyway). Moreover, the new Pension Protection Act-engendered trends toward auto-enrollment (nobody asks people to fill out a form to be covered by their DB plan) and asset allocation fund defaults (nobody asks participants to make the investments in the DB plan) are also widely touted as DB innovations that we have finally had the good sense to bring to the DC side of the world.

Don’t get me wrong—anything that turns employees into participants (and automatic enrollment surely does that) and helps them make better investment decisions (and, generally speaking, asset allocation solutions fulfill that need) has to be a good thing. But to suggest that these trends are essentially helping our DC programs mature into their more “responsible” DB counterparts represents, IMHO, a gross misinterpretation of what is going on.

The most obvious difference, of course, is that DB plans not only don’t ask employees to sign up or make investment decisions—they generally don’t ask participants to FUND them, either. In a DB plan, all the participant has to do is—well, they don’t have to do anything (other than continue to meet the eligibility requirements for the plan, and that’s generally been a natural outgrowth of keeping your job). Some might argue that that lack of involvement contributes to what continues to be a widely evidenced lack of appreciation for the benefit.

Another Difference

There is another big difference, of course, and it also has to do with how these plans are funded. Defined benefit plans are funded—at least, they are supposed to be—with an eye toward the benefit that will be paid out. As the name suggests, the benefit is defined—and the decisions that are made about how much to contribute to the plan and how those contributions will be invested are also done with that in mind.

Defined contribution plans, on the other hand—even the “new,” “automatic,” DB-ificated ones—have an entirely different focus. They are (still) about how much you can afford to put into them, not how much you need to get out of them. Oh, sure, the PPA’s safe harbor automatic enrollment includes a provision to increase those contributions on an annual basis—but starting at just 3%, and rising only to 6% of pay. That may well be all that many can afford to contribute—but is it any replacement for the kind of funding discipline that a true defined benefit focus represents? More importantly, will it be enough to provide the same kind of retirement security that the DB system promised?

Still, this notion of DB-ification keeps popping up. As though, through the graces of the PPA, we have managed to magically replace that missing leg on the three-legged stool of retirement security—when all we have really done is stick a piece of cardboard under one of the two remaining.

IMHO, we won’t really have a “DB-ification” of our defined contribution designs until we shift the focus—not just the funding.

- Nevin Adams

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