IBM reopens its frozen pension plan, saving the company millions
Traditional pension plans have not returned. But the news from IBM might prompt you to do so.
Last month, IBM thawed a defined benefit plan that was more than frozen 15 years past. The company has also stopped making contributions to employees' 401(k) accounts.
These moves are startling because, at least on the surface, IBM appears to be reversing a decades-long trend of companies moving away from traditional pension plans. Under the old plans, companies promised to pay employees a retirement income that rewarded them for long years of service. But these plans were expensive, and IBM and hundreds of other companies began emphasizing 401(k)s instead, which placed the primary responsibility for savings and investments on employees.
IBM's new approach is important because the company has been a leader in employee benefits policymaking. What it is doing now is not a simple return to the classic system of cradle-to-grave benefits. In fact, IBM's new retirement plan isn't nearly as generous to long-tenured employees as its predecessor.
This move has real benefits for some people who work at IBM, especially those who put little or no money into 401(k)s and stay with the company for a relatively short time.
Crucially, IBM's maneuver will likely be great for its shareholders. The company saves hundreds of millions of dollars a year by halting contributions to employees' 401(k) accounts. And it doesn't need to put money into the pension plan this year – and probably for years to come – because there is already enough money in it. From a purely financial perspective, IBM is improving its cash flow and bottom line.
For a small but important group of companies — those with fully funded, closed or frozen pension plans — IBM's move could be a harbinger of things to come, pension consultants say. IBM is using a surplus in its pension fund to simultaneously change its benefits package and help the company's finances.
“You'll see this more often,” says Matt Maloney, senior partner at Aon. “But I don't think this is really a turning point, because not many companies are in a position to do what IBM is doing.”
Basics of Retirement
IBM is calling its new retirement plan a “retirement benefit account.” It is legally and bureaucratically embedded in the old version. Because it is part of the defined benefit plan, the new plan is supported by the government Retirement Benefit Guarantee Corporationwhich will pay benefitsup to certain limits, if the plan runs out of money or if the employer goes bankrupt.
Unlike 401(k)s, with retirement plans “the employer makes the contributions, owns the assets, selects the investments and bears the investment risk,” says Alicia Munnell, director of the Center for Retirement Research at Boston College.
Employees are immediately covered by the new IBM plan and can take their money with them when they leave, IBM says. So far, so good.
But for many employees, the change comes at a cost.
IBM will no longer make contributions to employee 401(k) plans. Until now, it has made 5 percent matching contributions and 1 percent automatic contributions, according to internal documents posted publicly and whose authenticity Jessica Chen, an IBM spokeswoman, confirmed. That money and those accounts belong to employees. It took a year for employees to get onto those accounts.
The new pension accounts are part of a so-called cash balance plan, a pension scheme in which the employer determines how the money is invested.
In the new IBM accounts, employees will receive credits worth 5 percent of their salary – 1 percentage point less than the company's maximum contribution to the 401(k) previously. In the first year alone, employees will receive a 1 percent salary increase to make up the difference in contributions between the old 401(k) and the new retirement accounts.
Risk and return
IBM documents show that employees in the new accounts are guaranteed a return of 6 percent interest for the first three years – an excellent rate under current market conditions.
From 2027 to 2033, returns are likely to decline. Employees receive the return on government bonds with a ten-year term, with a floor of 3 percent. From 2034 there will no longer be a floor. So if government bond yields fall below 3 percent – as was mostly the case between late 2008 and early 2022 – a paltry return is all workers will get.
Keep in mind that employees in a 401(k) are free to invest as they wish. Those with a long investment horizon may prefer the stock market, which typically delivers higher returns than government bonds over longer periods of time.
While IBM employees can keep their 401(k)s and continue adding money to them, they won't get the incentive of a company match. How many will continue to contribute remains to be seen. In the new accounts, employees only receive fixed-income investments.
That may be fine for people who are retired, but it is questionable for people who will be in the workforce for years to come. Employees may need to increase stock allocations in their 401(k)s or other accounts.
The background
At the height of defined benefit plans in the 1970s, as many as 62 percent of private sector workers were covered exclusively by these pension plans, according to the Employee Benefit Research Institute, an independent organization that researches retirement issues.
By 2022, found the instituteOnly 1 percent of private sector wage and salary workers had only a defined benefit plan, while 41 percent participated in only a defined contribution plan – or 401(k) – and 8 percent participated in both.
The underfunding of occupational pension schemes led to the major shift away from defined benefit schemes. Initially, 401(k)s were supplemental savings tools for employees. Now, 401(k)s, along with Social Security, have become core elements of retirement.
By closing the old defined benefit plans to new employees and freezing benefits for people already involved, companies reduced their potential pension liabilities. They put money into the old pension plans to bring them into line with government rules, which had been relaxed for companies relief.
But smart management and cooperative financial markets have also helped increase the financing of the plans. Because pensions are a form of annuity, the rise in interest rates in recent years has accomplished this cheaper to finance existing pensions. In addition, strong equity returns over the past decade have strengthened the fund's assets.
These factors have led to a major change in the financing of the old occupational pension schemes. (Public pension plans, by contrast, face a funding gap of an estimated $1.45 trillion, according to the Pew Charities.) For large companies, the average private pension plan now has more than enough money to pay off its pension obligations. For defined benefit plans at S&P 500 companies: says Aonfunding levels rose from 78.4 percent in 2011 to 102.7 percent on February 6.
It comes down to
IBM's defined benefit plan is now extremely well funded. Its annual report shows it had a $3.5 billion surplus in the plan last year while making $550 million annually in 401(k) contributions. It doesn't have to put new money into the retirement plan and now, with the shift to the new retirement accounts, it doesn't make 401(k) contributions either.
Professor Munnell estimated that IBM could credit employees with benefits on the new accounts for at least the next six or seven years. Several pension consultants said that if market conditions were favorable and IBM invested the $3.5 billion surplus at a higher rate of return than the fixed-income rates it offered its employees, it might be able to avoid deploying cash on these benefits for years. .
The company said its pension innovation improved its finances. In a Jan. 24 earnings call, IBM Chief Financial Officer James J. Kavanaugh said the company's cash flow was better this year, in part because of “lower cash needs due to changes in our pension plans.” That could be the case for years to come.
Other companies with frozen plans that are fully funded could follow IBM's lead.
This is not a return to the richer benefits for long-tenured employees offered by traditional defined benefit plans.
But perhaps cash balance plans combined with 401(k)s are the best that most major companies are likely to offer. If, Zorast WadiaAccording to a director and consulting actuary at Milliman, the pension consultant, there are several ways to design pension packages that use pension scheme surpluses. Unlike IBM, for example, some companies could continue their 401(k) contributions while starting a cash balance plan.
Finding ways to use well-funded pension plans generously but responsibly is a challenge for large companies. IBM has proceeded cautiously. But it is in no one's interest for companies to make pension promises that they cannot keep.