From the February 2011 issue of Treasury & Risk magazine

New IRS Rules Could Give Hybrid Pension Plans a Boost

As the economy struggles, U.S. companies continue to shift from defined-benefit pension plans to 401(k)s. The most recent example is General Electric, which closed its pension plan to new salaried employees at the end of 2010.

As a recent Bank of New York Mellon survey of public and private pensions notes, "Plan executives know they will pay now for retiree benefits, or they or society will pay later." But "unprecedented cost pressures" faced by U.S. retirement plans have been forcing providers' hands, the report says.

Now, however, help is on the way for companies that view pensions as an important tool. (According to the BNY Mellon survey, more than half of company executives say retirement plans make recruiting more competitive).

The key, say pension experts, is a set of new regulations from the Internal Revenue Service that will govern so-called cash-balance, or hybrid, plans, which share features of both defined-benefit plans and defined-contribution plans.

The first hybrid was set up by a major U.S. company in 1985, when 89 of the Fortune 100 had DB plans, says Alan Glickstein, a Towers Watson senior consultant. By 2003, one-third of Fortune 100 companies had hybrid plans. But a lack of clear regulatory guidelines slowed things down, and some companies with hybrid plans even shifted to 401(k)s. Today, only 24 Fortune 100 companies have hybrid plans, while 17 have traditional pension plans.

The proposed IRS regulations aim to provide clearer rules for hybrids, although they face criticism from groups representing plan sponsors. For example, the ERISA Industry Committee argues in comment letters that the maximum interest rate at which plan assets can accrue is too conservative and would leave many existing hybrid plans out of compliance.

Glickstein says, however, that once the regulations become final late this year, they should encourage companies to offer hybrid plans. Employers favor hybrids because, since benefits accrue earlier and are typically paid as a lump sum at retirement, sponsor liability is more predictable.

"It will be interesting to see if we see a boomlet in these hybrid plans once the regulations are adopted," Glickstein says.

"Especially given the recent bad experience people have had with 401(k) plans," he adds, "we think there will be a lot of rethinking regarding 401(k)s."


For an update on moves by sponsors of defined-benefit pension plans, see
Facing Up to Pension Underfunding.

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