RECORD OF SOCIETY OF ACTUARIES
1986 VOL. 12 NO. 1
THE BETTER ALTERNATIVE? -DEFINED BENEFIT OR DEFINED
CONTRIBUTION
RETIREMENT PLANS
Moderator:
F. JAY
Panelists:
LARRY
ERIC
Recorder:
The
LINGO
LANG
P. LOFGREN
MICHAEL
pros and cons
ee objectives,
discussion
of both
and which
of the range
MR. F. JAY LINGO:
primary
purpose
ROBERT
types
of hybrid
from a traditional
approaches
being
for such
with
publications
Touche
World and
plan and setting
up a defined
some quantitative
projections
benefit
plan and
contribution
Eric Lofgren
actuary
providing
clients
and
actuarial
Benefit
Our
Contribution
with
and
Lang is an actuarial
He has written
the Journal
a case study
plan.
under
that
the firm,
account
I think
in the New York area.
399
Planning
a defined
His work involved
the current
you will
in New York.
to many
find
defined
inter-
Eric is a con-
and his responsibilities
management
articles
he has put
terminating
contribution
plan
several
of Pension
that
on the values
is with Mercer-Meidinger
principal
services
Minnesota.
and Defined
Larry
who was considering
putting
suiting
A
be included,
in Dallas.
benefit
esting.
and employ-
be highlighted.
and then at some of the hybrid
summarize
for one of his clients
defined
Employer
will
Ross & Co. of Minneapolis,
our panel members.
will
meets,
days.
as Pension
Larry
be debated,
plans also will
The Wyatt Company
and Compliance.
together
will
of plan
standpoint
used these
like to introduce
consultant
type
is to take a look at Defined
Plans, first
i would
of plans
ones each
I'm with
RAHN
include
of Mercer's
larger
PANEL
I would
like to spend
did for purposes
DISCUSSION
a few minutes
of measuring
outlining
the
variability
historical
basis of some sample
defined
The study
was not particularly
concerned
because
we chose random
defined
benefit
ment ratios
areas.
that
study, at least
ment
that
may not
retirees
benefit
extent,
that
to that,
defined
cost efficient
way
important
retirement
plans,
may lead
important
I/1/85.
period,
We assumed
beginning
that
each
of the
For purposes
of the defined
assumptions
with
to historical
index
dividends
were
assuming
ment
return
the total
re-invested.
over
those
salary
annuity
rates
defined
contribution
wages
rates
approach
were
we used
30 year periods.
from
individuals,
one year
balances
to annual
had 30 years
400
plans
up
and
are
at age 65
of service
plan,
at
was equal
we had to make some
return.
We used
two
were made in the S&P 500
investment
Brothers
as another
respect
income
Bond
measure
to historical
Index,
rates
of
increase
We used PBGC
immediate
retirement
to convert
amounts.
date
or
of invest-
we used the average
at each
benefit
benefit
of these individuals
to the next.
at age 65 that were in effect
in setting
and so on, through
the Salomon
With
or
I_; is
that we made that
assuming
re-invested,
or"
benefits.
who retired
of investment
return
to
cost effective
involved
defined
1/1/77
contribution
investments
for these particular
Security
of each
that
Second,
that dividends
increases
in Social
we assumed
and used
again
salary
respect
First,
then
individuals
to $30,000.
stock
annual
benefits
retirement
objectives
from
vehicle,
objective
assumptions
and
this
is a primary
at 10 employees
I/1/76,
that
As a
were certain
on
I think
be provided.
plans.
retirement,
alternatives.
the final
away
and
of replace-
teeth in the argu-
contribution
We looked
contribution
may not be the most
are many
plans.
level of benefits
retirement
will
can provide
lead
on a
as a sole retirement
benefits
plans
and some of these
this study there
over a 10 year
adequate
that there
to keep in mind.
used
we
benefit
the variability
of time.
levels
an employer
to the use of defined
In performing
with
adequate
benefit
contribution
in which
to keep in mind
when
of providing
adequate
when providing
_Ian sponsors,
the specific
in the defined
that
ratios
and defined
put some quantitative
plans,
be the best in tc,ms
corollary
formulas
contribution
or assuring
about
over a I0 year period
to a certain
of a study
of replacement
contribution
We were more concerned
resulted
defined
the results
THE BETTER
The following
bution
benefit
plan,
We looked
offset
formulas
the contribution
at two different
plan; the second
times final
average
average
salary
These
used
formula
defined
in the study.
was equal
benefit
Both defined
For the defined
to 7.5% of annual
formulas.
was a non-integrated
salary.
plan,
The first
was a 50-50
1.5% times years
benefit
formulas
contri-
compensation.
of service
used a 5 year final
basis.
With this background
important
were
ALTERNATIVE?
to note
in mind,
that Table
are retirement
let's
look at the numbers
1 does not include
plan formula
benefits
only.
TABLE
1
REPLACEMENT
Without
Formula
we came
Social Security
up with.
It is
benefits.
RATIOS
Social
Security
Standard
Deviation
Variability
Factor*
Range
Mean
o S&P500
43-56%
49%
4.59%
.09
o SalomonBros.
21-27
24
2.45
.I0
DB-Offset
28-37
32
3.38
.11
DB
38-41
39
.87
.01
DC
*Standard
Deviation
Divided
by Mean
On the DC side, over a 10 year period,
replacement
ratios
range
deviation
of 4.59%.
deviation
by the mean.
We computed
another.
ratio
With a mean of 49% and
a variability
This is something
You can see that the salary
went from
using the S&P 500, we found
from 43 to 56%.
replacement
factor
we did to normalize
ratio
ranges
the DC plan to the DB plan and from
For instance,
range,
the Salomon
you would
Brothers
based
expect
basis.
varied
Replacement
standard
ratios
401
had
the comparison.
lower
as you
return
the highest
deviations
were
the standard
somewhat
one investment
on the S&P 500, which
some wider
by dividing
that the
a standard
than
simply
basis to
replacement
you would
because
of
for
PANEL
the investment
factor
factors
rates
of return
down
non-integrated
from
the Social
$30,000
Security
believe,
final
salary
benefits
benefits
that
payable
find
period
side either
factor
replaced
a higher
through
ratios
on that DB plan from
1/1/85,
If you were
those
of that
the actual
I
to about
the
Security
(Table
2), what
variability
whereas
you
factors
on
the DB offset
5%.
2
REPLACEMENT
Without
period,
progression,
37% down
ratios
down to about
TABLE
Formula
is that because
percentage
to add Social
plan, those
level or increased,
halved,
plan
and as a consequence
smooth
replacement
for the DB offset
stayed
almost
with the DB offset
was a relatively
at age 65 into
variability
the variability
to as low as 2% on the
There
of time.
is that except
the right
You can see that
1/1/76
of the replacement
over
the variability
of $30,000 a year over the 10 year
have actually
has decreased.
28% level
more valid.
up with
9% for the DC plans
as you move from
DB benefit
So we came
DB plan. What's happened
we've used a constant
would
involved.
to make our comparison
range
DISCUSSION
RATIOS
Social
Security
Standard
Deviation
Variability
Factor*
Range
Mean
o S&P500
63-82%
72%
6.21%
.09
o SalomonBros.
35-55
46
7.19
.16
DB-Offset
50-59
55
2.74
.05
DB
52-69
62
5.60
.09
DC
*Standard
Deviation
In summary,
fortable
Divided
these numbers
with the assumptions
ity on a defined
contribution
look at non-integrated
by Mean
quantify
the fact that, to the extent
you are com-
that went into the study,
there
plan than on the DB side,
particularly
DB plans.
402
is more variabilwhen you
THE
MR. LARRY
basic
LANG:
qualitative
detail,
defined
because
between
Which
What I will
differences
the traditional
Of course,
with and the company
(is it a young
who need to be attracted
the employer
actual
and
versus
DB plans
generally
this is borne
risk,
Understandability
the DC
is one area
slower
under
versus
a DB and
that
from
the
to people
age
to employee
long service
has an overriding
no range
items.
just one for a DC plan.
the direction
With respect
somewhat
to do that.
group
DC plans.
under
With
a DB plan
now are two numbers
to become
as we listened
to Dallas
I think
of the DB program.
403
I
the
are
flexibility
offers
except
with
in light
to
under
of FASB
a DB plan
may be the activities
Salisbury
we got the sense that the pendulum
over
schedules
a DC plan,
concerned
factor
overnight,
advantage
a
under
on a year to year basis.
One is expensing.
The second
problems
Funding
at all under
are varied
under
more difficult
DB vesting
the DC plan.
themselves
there
I think
or most of the money,
by the employer
really
versus
Luncheon
of a DB versus
contributions
who seem to prefer
under
87-88,
and
versus
for an older,
faster
Let me also add two other
Washington.
group.
to solve new retirement
is unable
the benefits
for
and perceived
a DB plan and large or substantial
the DB plan
really
risk tolerance
differences
is generally
Flexibility
where
which
employee
executives
a DC plan. The size of what I call a severance
to be very small under
DC program.
the extent
appeal
older
risk tolerance
income
money,
employees,
under
a range
define
you are
flexibility,
high paid,
55 for the DC plan.
have
to investment
somewhat
plans
service
the employee
DC program,
plan and
the variations
that
funding
investment
inflation
to the employee
age
versus
a DB versus
about
on the client
desired
or are there
distribute
under
short
tends
depends
into the workforce?),
respect
think,
group
benefit
versus
younger
benefit
that
the employee,
DC plan. They generally
appeal,
you at some length
some of the basic qualitative
Defined
55 and over
on the
benefit
I'm not going to get into a lot of
objectives,
value in relation
Let's talk about
a DC plan.
plan.
defined
two extremes.
characteristics
versus
our traditional
contribution
one is better?
both
ALTERNATIVE?
try to do is to give the big picture
between
Eric will talk with
these
dealing
BETTER
at the Business
is starting
in
Section
to swing back in
PANEL
With that
behind
DISCUSSION
us, let's look at an actual
the client
the DB plan and
moving on to a DC program.
Company,
There
was giving
case study
In this situation
serious
of $35,000,
average
age of 33.8, and average
was 60% of pay less 60% of Social
Vesting
was 4-40, normal
mcnt age.
were
using
inlcrest
rate
was that
the standard
to the value
used
there
to year based
tions
that
1/15, 1/30
was
sensitivity
rate and
I think
reflective
to have a fair comparison
with
cost such
much
that
over
more than
obtained
time
100%.
are clearly
I'll
show
it would
I should point
costs
of 3.5% to 5.1% under
it was credible
lower
you that
based
with
and
I came
I settled
but I feel I probably
remarks
ratio
Unit
a
(BSR)
not
that
I have
contribuof funding
on 4% because
of producing
Credit
rather
a range
could
in
to the funding
the defined
up with
year
assump-
Jay's
cost, but
the results
side, favoring
that
conditions
security
out here that
upon the objective
factors
the Projected
the funding
the two methods.
benefits
rate from
market
up a benefit
in a minute.
with the client,
percentage
build
on the conservative
plan.
of current
to find
was a
the
tied it to investment
it is consistent
Age Normal
not being
tion
and other
of the two plans. With respect
at both the Entry
the objective
retire-
there
study
to vary the interest
we will be considering.
I looked
required.
at 8%, and w:hat I discovered
to inflation
interest
pay
The benefit
and disability
In the actual
fixed
for this study
upon the market
methods
average
with 30 years
Death
benefits.
factors
little
I decided
method,
of 2.4 years.
Security
factors.
that you need to have something
order
service
company.
payroll,
at age 55 and 10 years of service,
of retirement
:for option
was very
we will discuss.
in covered
Widget
form was life only, and age 65 was the normal
For early retirement
equal
to terminating
it the Ultimate
of a multi-national
with $3.15 million
formula
subsidy
Calling
this was a 5 year old U,S. subsidiary
were 90 participants,
for one of my clients.
consideration
I thought
have justified
a
BSRs in the range
of
100%.
Having
established
the current
that is, to terminate
starting
(this
account
was deemed
er's standpoint
then happens
program,
the DB plan,
balances
let's look at the proposed
use the resulting
in the new program,
to be the long term
the same amount
to the individuals
and
lump sum values
annually
is going into either
as far as their
404
projection
4% of pay
the employ-
program).
of benefit
--
as
contribute
cost of the DB plan_ so from
of money
program
What
values?
THE BETTER
A forfeiture
adding
assumption
onto their
into their
accounts.
Fastback,
Lowcareer
relatively
young.
compensated;
Security
include
increases,
A range
of
factor.
that
paid,
and
short
service,
not as well
With respect
include
the salary
increases.
to the
rate and the earnings
and the
scale, Social
Investment
assumptions
credited
sets was actually
about
studied,
today.
to the defined
in inflation
and
sets and allow
and, separately,
a 3% spread,
bumps
the interest
if we had enough
It makes more sense, however,
assumption,
and 4% inflation.
assumption
bumps
there,
Ultimate
but I have two ratios
Value
Ratio
is determined
at age 65, determining
and then dividing
plan.
time,
to
to test
to changes
6% as a wage
We will then look at 8%
up to 13% and the wage increase
at the 4% inflation
it down to 7%, 6%.
the ratio of the DB plan value
of all plans
ourselves
test sensitivity
to 10%, and we will also look at a 1% spread
We're almost
competing
limit
to look at,
both the wage assumptions
So we will use a 9% interest
assumption,
assumption
The
drives
a few of these assumption
to changes
in the spread
is simply
highly
longer service
level individual.
and 415 benefit
16 assumption
sensitivity
level that
is fairly
Wage assumptions
have been talked
focus in on just
inflation
individuals
are
of 4.5%
plan.
they could
increase
sample
Fastback
inflation
here both the interest
contribution
0.5% of pay for a total
is a bit older,
obviously
assumptions.
by the 6th year partieipants
three
Young is an entry
used,
investment
created
and Young.
Loweareer
so that
an additional
We then
and
assumptions
was added
contribution
ALTERNATIVE?
that amount
to define.
The Relative
Value Ratio
to the DC plan value at any age.
by first
the largest
calculating
amount
into the stream
As you see, this normalizes
the lump sum
for all competing
of benefit
values
value
plans
for each
the results
so that
the strongest
expect,
DC has a substantial
plan at age 65 has a value of 100%.
With
Fastback,
advantage
tionships
early
prior
flip
subsidy,
pop-up
1/30 to 1/15.
By the time Fastback
so that the ratio
retirement
A second
to age 55, as we might
over the DB plan.
there
approaches
200%.
is a substantial
the
reaches
At age 55, because
pop-up
at age 60 is due to the early retirement
Now
let's consider
sensitivity
to inflation;
405
age 65 the rela-
in the benefit
factor
there
of the
value.
changing
is an inverse
from
PANEL
relationship.
As you increase
competitive.
It keeps
has a very
advantage
of the DC prior
similar
of course,
she is better
enhanced
by higher
off
plan is ahead
at all ages under
inflation
small when
values
For example,
benefit
and after
plan.
increase
that
between
I won't
talk about
in a non-:integrated
This
with the ultimate
the amount
is further
value
by Fastback.
of that
Here
advantage
turns
the ultimate
Incidentally,
he just might
to spread,
out
lump sum
Lowcareer
is a real
the spread,
you
has a similar
Young hasa
pattern
DC plan more
if you pick the assumptions
it can cross.
there
keep his defined
as you decrease
in any great detail.
in time where
ratio.
to 55 the DC
age 55 and 65, well over 80% of the
of the DB plan.
for all ages, but
point
low salary
the DC plan.
this information
As for sensitivity
the competitiveness
competitive
certain
seeing
factor
interest
decreases.
you put it on a scale of what
lump sum value is earned
Fastback
benefit
of
As we pointed
As that
of course, that prior
However,
to be relatively
ultimate
to spread
It is true,
of a DB plan.
will be.
The
levels.
sensitivity
are different.
of her
as acute.
of an option
to the earnings.
Because
less
nor is the advantage
is the same.
the value of the defined
pattern.
DC plan,
Now let's consider
credited
becomes
as dramatic.
is not quite
as great,
of course,
plan
quite
here is due to the selection
rate increases,
has a different
benefit
55 but is not
but the slope
Sensitivity,
to the interest
the results
pattern,
relationship
that is related
Young
the defined
beyond
to 55 is not quite
DB at age 65 as great.
out, the inverse
inflation,
its advantage
Loweareer
the
DISCUSSION
right,
And it does at about
there
is a
age 60 in this
instance.
Let's summarize
I don't
offer
observations
Generally,
some of the observations
these as general
agreeable
the defined
DB plan better
continues
to improve.
plan is better
because
after
However,
with what
we would
contribution
plan
age 55.
For higher
expect
appears
retirement
Also,
a substantial
subsidies.
to this particular
I think
from
better
these
prior
study.
you will find the
two programs.
to age 55 and the
paid people this DB advantage
For low paid individuals,
at all ages.
of early
with respect
conclusions.
it can turn
pop-up
Looking
406
in value
instead
out that
the DC
can occur
at the ultimate
value
THE BETTER
ratio,
we are forced
turns
65.
to conclude
out to be relatively
Now this point
young,
tivity
small
when compared
we've
the defined
for capital
For similar
there
are several
One that
I would
wish to consider.
a non-integrated
that
Young
the DC plan,
industries
tivity.
to do better
but that Fastback
or fix the option
We could
comparison
One
tend
consider
might
factor.
adding
find
to this study
interesting
I think
we
This produces
balance
that
one
to look at would
be
what we would find
the DB plan,
not do as well.
a cash
reasons,
or at least
closer
We can examine
a lesser amount
feature
to the
is
to
mature
of sensi-
DB plan for
purposes.
big question
in between
regarding
that
is certainly
the two traditional
a number
contribution
This
which
of programs
are
With that, Eric will visit with us
and
framework
what
about
differences
traditional
a conceptual
is really
the variations
I am going to be talking
are merely
try to put together
is what
plans.
dichotomy:
which differences
ent hybrids.
open
extremes.
of hybrid
MR. ERIC P. LOFGREN:
defined
variations
under
to sensiis
factor.
DC plan that costs 4% of pay.
would
With respect
is decreased.
Let me also point
at age
at the most, with an
As inflation
advantage
to 55
values
relationship.
to the spread
might
prior
that needs to attract
accumulation.
see the same kind of sensitivity
that
to the ultimate
for a client
seen an inverse
benefit
out
DC advantage
They may stay 3 to 5 years,
and are looking
to inflation,
increased,
the apparent
may not be pertinent
high tech individuals.
organization
that
ALTERNATIVE?
we want
the defined
are absolutely
not necessary.
within
which
to discuss:
benefit/
inherent
and
Then I'm going
to analyze
different
to
the differ-
hybrid
approaches.
The most common
approach,
benefit
contribution;
or defined
plus a 401(k) might
Frequently,
ment income
usually
be typical.
it's really
needs and a defined
is the contribution
benefit
large
plans,
one of each.
And this is not often
it's really two programs.
happens
the defined
at least among
It's a defined
contribution
plan
plan
is not the defined
The defined
a coordinated
benefit
407
program.
plan for retire-
for savings
is very enthusiastically
plan is not well regarded.
benefit
plan needs.
received,
When the two plans
What
but
are looked
PANEL
at separately,
quacy,
there
and for
combined
is no consideration
young
benefits
competitive,
since
icant
The
people
is visible;
employees
good feelings
The account
are accessible
can actually
an employer
stock
towards
isn't as favorably
option
received.
be working
for the same company
30 years
which
is common,
it may
they
years.
From
the employer
cost can often
perspective,
seem quite
inflated
some type of plan is needed
since
in relation
for retirement
often
income.
for defined
wanted
to have some type of different
packaging.
cussed
necessary
into
differences
really
retirement
income.
it cannot
ments
benefit
a specific
inflation
plan
does have
benefit
subsidies
defined
contribution
flexible
basic secures
because
of annuity
defined
plan.
On the other
options
Perhaps
subsidy),
for employee
most important,
securing
hand,
but
investment
rates or investThe defined
doesn't.
design
in that
is difficult
the defined
choice;
specific
of unknown
purchase
benefit
dis-
a contribution,
contribution
which
it can
under
a
contribution
plan
this is not so with the
the defined
408
but they
The necessary
basics:
at the time of retirement.
funding;
retirement
purposes,
differences.
benefit
the
Nevertheless,
I've seen a lot of embenefit
benefit
plan has a more flexible
(early
can have investment
benefit.
depressed
10
that Larry
contribution
retirement
for
bene-
pre-funded,
the differences
and optional
and the possibility
temporarily
provide
down
to the defined
The defined
being
The defined
defined
differences
come down
promise
performance,
to break
to
Security
Accrued
not vested
to the benefits.
feel they need something
about
is a Social
is being
will
in
intend
away.
The
It
which
plan,
necessarily
the plan
that
1 and 2 I've tried
option,
look like a take
needs.
grow.
savings.
benefit
hence. If there
ployers
In Exhibits
net worth
may not care
don't
fits are very low in the early years, and they're
re-
can be signif-
for employee
Most employees
and since
formula,
their
The defined
since it's so far away
or poorly
balances
as an investment
the employer.
But you end
for non-retirement
watch
and it is tax effective
retirement,
offset
very popular
the
of being
the same approach.
that are either
will be popular.
plan is easy to understand,
contrast,
are
ages, and the funds
even have
ade-
retirement,
It does have the advantage
The 401(1<) plan
foster
benefit
until
using
companies
with portions
might
retirement
may be very generous.
at the young
account
of overall
who stay all the way through
so many
up with a program
garded.
DISCUSSION
contribution
plan
can
THE
accommodate
defined
plan
pre-tax
benefit
in order
contribution
employee
can't.
ALTERNATIVE?
contributions
What an employer
to get the pre-tax
and
BETTER
employee
to get the secure,
through
the 401(k), which
may really
contributions
specific
the
need is one of each type of
from
retirement
the defined
income
from
the defined
benefit.
EXHIBIT
DEFINED
BENEFIT
1
VS. DEFINED
NECESSARY
CONTRIBUTION
DIFFERENCES
Defined
Benefit
Defined
Contribzttion
o Investment Risk
Employer
Employee
o Salary Growth Rate Risk
Employer
Employee
o Funding Flexibility
Yes
No
o
Yes
No
No
Yes
No
Yes
More
Less
No
Yes
Benefit
Subsidies
o Individual
o
Employee
Allocation of Trust Balance
Investment
Options
o RegulatoryImpact
PBGC Premiums
Funding
Standards
Contingent
o
Pre-tax
Employee
Termination
Liability
Contributions
409
PANEL
DISCUSSION
EXHIBIT
DEFINED
BENEFIT
2
VS. DEFINED
TRADITIONAL
CONTRIBUTION
DIFFERENCES
Defined
Benefit
Defined
Contribution
o BuildupPattern
Slower
Faster
o Plan Defines
Income
Lump Sum
o
Older
Younger
o Vesting
Slower
Faster
o Cost for a Given Income Level
Lower
Higher
o Individual Accounts
No
Yes
Employee
Now
there
-- which
appeal
Appeal
arc other
don't
to young
employees
it as a lump sum.
it's merely
It doesn't
have
explore
here today
contribution
what
The starting
because
Vesting
expense
income
reduction
defined
is typically
plan
available
benefit
that
plan.
the confines
of hybrids
-- what
quicker
of
and
characteristic;
in defined
has shown
differences
plan is typically
contribution
faster
in the defined
plans in terms
2 -- traditional
contribution
is what we can do within
has usually
point
in Exhibit
it has more money
cash balance
accounts
contribution.
you can express
What we want
of defined
is really
to
benefit,
possible,
not
been done.
in pension
ment goal, as some specific
replacement
shown
The defined
not a necessary
to be. The
as individual
simply
That's
traditional.
things
defined
differences,
have to be there.
analysis
plan design
income
level.
that would
in retirement,
subtract
(Exhibit
3) is to develop
This would
typically
take pre-retirement
Social
410
Security
salary,
benefits
a retire-
involve
a
look at
and income
shows
THE
from
personal
savings,
BETTER
and leave
a net benefit
conjunction,
not as a second
component.
What type of savings
This is different
because
either
Experience
expected
adapt
from
might
return
selecting
diverge,
plan
patterns
of values
benefits
as retirement
you can express
prior
benefit
deferred
retirement
Finally,
benefit
vary
that,
TO PENSION
PLAN
DESIGN
goal
benefit
buildup
III.
Express
or lump
sum?
IV.
Select
pattern
the cost, because
income.
your savings
can go upwards
as income
ERISA
category:
can be expressed
retirement
The
(Exhibit
4).
I am talking
benefit
The higher
o
For
the same
more than
the buildup
pattern,
of providing
of
is what
the
the same
income,
as you
the cost will go upwards.
It
by 50% to 100%.
BUILDUP
The higher
value
of those accruals
the same retirement
naturally
EXHIBIT
o
sums or as present
accumulation
in the context
upwards,
pattern
DB or DC
as lump
income.
If you are providing
plan
the
3
Select the accrued
accruals
to express
early are big,
plan.
Set the retirement
vested
you can
buildup
we'll come back and
contribution
I.
benefit
retirement
after
II.
I mean by buildup
higher
whether
If the benefits
or defined
APPROACH
deferred
step,
to different
sum. If they are small, you are going to talk
EXHIBIT
Yearly
goal by itself.
but you can aim for an
you decide
or a lump sum.
income.
a defined
Then
plan
your plan?
contribution,
As a second
contribution
In
plan
for from
income
earlier,
income.
to retirement.
them as a lump
look at choosing
or defined
retirement
retirement
income
the plan.
level are you looking
defined
or defined
from
select the savings
as has been explained
and expected
benefit
needed
step but as a co-step,
one can get at an expected
a defined
about
ALTERNATIVE.'?
the buildup
pattern,
retirement
income,
a defined
benefit
4
PATTERNS
the higher
the plan cost.
a defined
contribution
plan.
411
plan might
cost 50%
PANEL
In the top graph
salary
in Exhibit
is the increasing
defined
under
a defined
bution
5, the straight
total value
contribution
plan.
benefit
where
The bottom
benefit
accruals
start
higher
yearly
accrual
at 65, maybe
25% of salary.
The
a traditional
accrual
pattern
contri-
except
at the last point
for the same retirement
age 55, at which
defined
The
defined
up to the defined
point
contribution
in
income.
accruals.
2% and don't catch
until about
of
why the defined
the year-by-year
at approximately
contribution
under
very clearly
It is always
5 shows
benefits
as a percentage
side is your typical
if you're aiming
in Exhibit
expressed
of accrued
plan. This shows
it's the same,
graph
line
The downward
plan is more popular.
time,
DISCUSSION
they
climb
to,
stays at a level- 5% or so
each year.
In the early
tribution,
years
you can
times as much
is shown
benefit
with
end up with
as the defined
in Exhibit
6. The
vs. defined
contribution,
contribution
pattern
actually
works
top graph
shows
you get to the age where
of the defined
benefit
that
the defined
does relative
you can outpace
Exhibit
9, Equal
pattern,
but you wanted
Cost,
pattern
delivers
though
it has 4/3
there
shoots
4/3
illustrates
the retirement
value of the account,
the accrued
years
extra
yearly
accruals
the straight
up until
benefit.
1/3.
income
benefit,
Looking
This
value
for defined
the traditional
retirement
subsidies.
subsidy.
Then
the
line.
performance
interest
benefit
just as we have been showing,
retirement
is going
yields are.
to be tied
If you are very
not get the value.
happens
income,
4 or 5
benefits.
$100 on the defined
in a straight
contribution
what
be worth
Naturally
have early
is an early
and
con-
7 shows how the defined
which
it for the same cost.
the retirement
do you get that
If you have
upwards
yourself
would
of accrued
85% less accrual
accruals,
to what
of defined
that
value
Exhibit
in a lot of plans
value
fast track,
at age 45.
plan has the lower
pattern
balance
got $15 on the defined
benefit
8 shows
an account
is more popular.
to how your salary
buildup
present
until
Exhibit
early
benefit
contribution,
you've
defined
The defined
this typical
if you wanted
of the early
it's not until
is worth
age 51 or 52 are higher
412
defined
buildup
about
more.
at the bottom
line.
the early
The traditional
buildup
benefit
pattern.
age
Even
61 that
the
Only in the last 4
graph
in Exhibit
on the early buildup
9, the
pattern,
THE
BETTER
ALTERNATIVE?
EXHIBIT
5
VALUE OF ACCRUED BE}JEF_S
Defined
_
/
35
/
45
55
Defined
65
AGE
VALUE OF ANNUAL
BENEFIT ACCRUAL
I
Defined
Contribution
Defined
35
45
55
AGE
AI3
65
PANEL
DISCUSSION
EXHIBIT
BUILD--UP
6
PAl-FERN
DB-DC LUMP SUMS
1,6
l°.dL
1.3
1.2
1.
0.8-
i o.o-_
0.?0,80.5
"
0,4
ii _
0.3
0.2
0.1
0
;--35
- _ ....
40
x ...............
45
50
55
SO
_ Van
1011DC
VcmInterellt.Scllllr,_
OB
ANNUAL ACCRUAL
30%
!I _t. pay
28_
24%
22%
2O%
>, 16_"
14%
8%
6%
4%
2_
........
35
40
i ......
45
i ......
50
55
60
Interest, Salary - 10%
r_Van9B
+ VanDC
414
115
BUILD--UP
DB-DC
$00
PATTERN
LUMP SUMS
,oo
/
400
=
300
t
J_
v4/
_
m
_
EarlyRe-
_;X_
_
BOost
H
t-_
200
Z
;>
-1
•
100
0
;
35
40
45
r_
50
55
Interolt,Scllary
= 611
Vart DB
+
Van DC
60
65
BUILD--UP
DB-DC
1.8
1.7
PATTERN
LUMP SUMS
1o_
1.4
1.3
1.2
1.1
1.6
1
DCSalary
S1o.-Track
/ _
o,
_/t/
0.8
o.7
/
0.5
0.4
0.3
/f
"_
Fast-Track
0.I
_ 35
;, L,;.-_
40
T ,
O
, ....
45
Van
, ,..
50
Intere,t.Salar-y
DB
+
.
. , ....
55
= 6S
Yam DC
, ....
60
_"
O
0.2
0
=
;>
Z
_
Z/_a_r,
0.8
rn
X
65
Z
THE
BETTER
ALTERNATIVE?
EXHIBIT
9
EQUAL COST
VALUE OF ACCRUED BENEFITS
_,
De
/'_
35
/
45
Defined
I
55
65
AGE
VALUE OF ANNUAL BENEFIT ACCRUAL
%
u_
Defined Contrfbution
I"1
35
|
;
!
;"1
!
I
!
I'_
I
i
!
45
I
I
!
I
I
55
AC_
417
I
I
I
I
I
I
I
I
65
PANEL
Thinking
in terms
helps us analyze
contribution
defined
plan which
benefit
technically
plan
of the buildup
the hybrids
01an's
defined
Plan.
essentially
accrual
as The
The whole
cash." The cash balance
It is a defined
money
benefit
is developed
pattern.
Pension
Equivalent
benefit
l"ve been
it's simply
is the exact
contribution.
opposite
the earIy buildup
have
Credit
Plan
pattern
in a typical
what
decided
this was the level of benefits
to have a defined
potential,
is.
It's jusl
You have
because
which
a pattern
EXHIBIT
pattern
in between
in between
and a 40I(k),
these plans
is defined
iI, we know
buildup
These
that you wanted.
plan.
tq_e late buildup
the cash balance
benefit
Account
got
of the traditional
approach,
l've been showing.
plan.
you decided
pattern
is
or the
you've
benefit
Thus, if we go Exhibit
pattern
Wc know
because
a lot of consulting
a plan that
A cash balance
of the target
The standard
plan buildup
showing.
you really
pattern.
Reserve
goal
a traditional
more than
with a late buildup
income
plan is a defined
to simulate
It is nothing
and 401(k), ends up in between.
pattern
benefit
plan with the early buildup
defined
what the targel
what
to meet a set retirement
10). A target
point of this plan is to say, "Employee,
plan
benefit
purchase
pattern
(Exhibit
contribution
is also known
Balance
DISCUSSION
is;
arc
simply
not because
This situation
you
offers
are not coordinated.
10
HYBRIDS
Target
Benefit
Cash Balance
Defined
Plan."
Plan."
Benefit
Floor/Offset
+ 40I(k):
Plans:
Defined
contribution
buildup
pattern
Defined
benefit
buildup
pattern
In between
Start
buildup
at defined
switch
plan
with
with
a defined
benefit
contribution
benefit
contribution
buildup
buildup
pattern
slow track
with young
investment
performance).
418
a defined
pattern
contribution
to defined
defined
plan
entry
pattern,
pattern,
always
higher
age and solid
unless
(e.g.
DC
THE
The
bottom
half
combination
of Exhibit
of plans
switching
BETTER
11 shows
starting
off
to the late buildup
the retirement
attractive
savings
plans
I've seen implemented
that
a real cash
balance
to grandfather
you really
ing or the alternative
income,
we'll
balance
masquerading
benefit,
There's
been a lot put into writing
Both definitions
modern,
vests in a portable
for inflation
be funding
definition
pension
the employer's
flexibility
sum
it to career
so we can highlight
What money
after
Employee:
plan. It's our way to disguise
we're going to change
lump
will probably
"Dear
Just
12).
it
be interested.
of a cash balance
allow near
is
each employee
to increase
options
term
plan
of both
is guaranteed
is simplified,
plan.
The first
A cash balance
there
savings."
will
The second
We've got for you a cash balance
in your
We'll express
will be directed
towards
to make sure, we'll reduce
benefits.
subsidies."
419
First
the benefits
interest
employees
early
at
at retire-
and
the use of the CPI, a sub-market
is left in the plan
just a few years.
(Exhibit
might
benefit
the cutbacks
average.
plan
I am emphasizing
the advantages
which
are many
side, administration
which
goes like this:
There
with
benefit
Easy to understand,
lump sum account
protection.
on retirement
directions.
"Dear Employee:
contribution.
the CPI
From
and
we need to focus
the 401(k) plus
people
two definitions
defined
quickly
ment.
and many
new plan design
benefit
grandfather-
It is a defined
were in the middle
flexible
defined
when
If
buildup
combination.
but they slant in different
definition:
formula.
early
The
young,
on this type of plan.
for your amusement,
are true,
is the upbeat
an exciting,
plans which
feel obliged
purchase
to counterbalance
it's been such a hot topic,
I've put together,
definition
or the floor
the
I've not seen
and we need to focus
concept.
contribution
providing
pattern.
a very attractive
is a very worthy
It's
the cash balance
they didn't
buildup
older
and then
because
have the money
is a
worlds.
as the minimum
means when you're
you're
plan
pattern
on. Actually,
formula
is the floor
I find this
plan
buildup
seen one yet where
defined
only because
earlier
you don't
When
floor
for when you hit 65 while
not
formula
as a defined
The
also have this pattern,
have
do that.
we'll do that.
The cash
the early
buildup
of those things,
What
on savings,
I've
plan.
It's the best of both
it or to put in the current
you do either
pattern.
with
income
income
plan.
the floor
pattern.
protecting
plan
ALTERNATIVE?
as a
rate.
who leave
retirement
PANEL
DISCUSSION
EXHIBIT
11
BUILD--UP
OI-I_
SO0
PATTERN
LUMPSUMS
....
ISO0-
4OO
cz_
z
lll_
DC
_CZ 200
1 O0
35
40
4!1,
"_
80
Von DI
S5
•
81}
85
VQ_ 0¢
ANNUAL ACCRUAL
30%
%of Pay
28%
26%
24%
22%
2O%
IB%
16%
12%
8%
10%
6%
4%
2%
0%
35
40
45
50
AGE
Interest, Salary - 6%
420
55
60
65
THE BETTER
ALTERNATIVE.'?
EXHIBIT
12
VALUEOF"ACCRUEDBENEFITS
One-_lf
ve_ned
C°nt ribu_
//
_'_
/
• ,
35
,
,
,
/
/
.........
Defined
,
45
,
, Benefit
,
.........
55
65
AGE
ACCOUNTBASEDPENSDN PLAN
With MinimumBenefit
?
35
45
55
AGE
421
65
PANEL
DISCUSSION
EXHIBIT
13
TARGET
PLAN
employees
(not merely
Objective.
o
Reach
goals for selected
actual
salary
performance
Contains
in meeting
all formula
features
new entrants),
and reflect
goals.
of DB plan
with
no unfunded
liabil-
ities.
But Target
Plans
can be difficult
to explain
to employees.
Operation."
o
DC plan
-- individual
accounts,
is actually
a type of money
purchase
plan.
o
o
Contribution
methodology
retirement
mortality)
Calculate
a projected
solve
benefit
defined
necessary
can reflect
factors
(interest
and post-
in plan.
(i.e., target)
for contribution
The target
and actuarial
are stated
to fund
benefit
pension
on attained
all the formula
and then
age level
variations
method.
of a DB
formula.
o
Self-corrects
funding
o
for past salary
of each year's
No mid-course
DC account
o
Benefit
corrections
is never
subsidies
progression.
benefit
Accomplishes
via attained
age
shortfall.
for investment
considered
in setting
performance.
year's
(That
is, actual
cost,)
difficult.
Uses:
o
DC plan with
o
Gives
higher
highest
o
Special
Exact
late buildup.
contributions
age-related
opposite
Constraints
of cash
and Legal
May be used with frozen
o
IRS has waived
which
if in conjunction
balance
o
basis
to older employees
leverage,
o
Qualifies
o
Integration
or terminated
discrimination
for FASB status
times
The
DB
plan.
former
DB plan.
tests so long as interest
rate in actuarial
projection.
snowball
hits 415 limits.
is 7/9
DC approach.
with traditional
Requirements:
= 5% to 6% and no salary
often
within
as DC plan.
DB limits.
422
This
causes
funding
THE
BETTER
ALTERNATIVE?
EXHIBIT
CASH
14
BALANCE
PLAN
Objective:
o
DB funding
early
flexibility
buildup
remove
combined
pattern.
early
Often
retirement
with higher
employee
used to camouflage
appreciation
a benefit
of its
cutback,
or
subsidies.
Operation:
o
DB plan -- no individual
pseudo
o
o
accounts.
Plan assets need not match employee
accounts.
Plan funding
is actuarial
based on projected
service,
it can be over or under-funded.
Benefit
formula
is usually
as in the contribution
To make
fixed
ly, this would
benefit
buildup.
benefit
buildup
express
for a money
investment
cash balance
purchase
credits
directly
pension
plan.
on account
%, wage index)
it look more
as the actuarial
1.
schedule
basis in plan for granting
(CPI, T-bill,
If plan has past
either of two approaches:
To make it look like a lump sum plan:
Specify
benefits.
like an annuity
present
promise:
value of an accrued
not be a very appealing
So, the following
express
cash
DB benefit.
lump sum amount
steps are used to create
balance
Generaldue to late
an early
pattern.
Determine
each
year's
accrual
by the career
average
formula.
For example:
o
2.
Pension
Index benefits
accrual = pension
benefit
each year via stated
423
of 1% o£ year's
index factor
earnings
PANEL
DISCUSSION
EXHIBIT
CASH
3.
Convert
BALANCE
to lump
The effect
Index chosen
PLAN
sum amount
of the indexing
or no pre-retirement
o
14 (cont.)
can simulate
stated
in plan.
in (2) is comparable
interest
career
at factors
discount
average,
final
to using minimal
to determine
average,
lump sums.
or money
purchase.
o
Variations:
1.
Can use as alternate
2.
Can provide
early
minimum
formula
retircment
in a DB plan.
features
and subsidies
via temporary
supplements.
3.
Grandfathering
common
at conversion.
Uses:
o
DB plan with early
o
Often
a disguise
buildup
for mobile workforce.
for a cutback
on benefit
subsidies
(i.e., early
retire-
ment subsidies).
o
Generally,
the indexation
ting much slower
is less than anticipated
funding
and contribution
o
Continues
DB funding
o
Employer
still gets excess investment
Special
Constraints
o
Full range of IRS Issues not fully
o
permitexists.
returns.
Requirements."
Recent
(1985), although
with 415 limits
earnings,
if surplus
for a DC presentation.
o
comply
hype
and Legal
latitude
fund
holidays
ancient
versions
explored,
and integration.
Can't be 401(k).
424
do exist.
but careful
design needed
to
THE
BETTER
ALTERNATIVE?
EXHIBIT
FLOOR
15
PLAN
Objective:
o
Provide
DB goal as minimum,
mance
on amounts
being
while giving
accumulated
employees
the upside
perfor-
in DC plan.
Operation:
o
Two plans (two funds,
two documents,
Offset
= self standing
Floor
= DB plan acting
two everything)
DC plan (any
type)
as a 2rid plan,
providing
an umbrella
and offsets
for "pension
benefit.
o
Floor
plan calculates
equivalent"
o
of DC account.
Floor plan pays a benefit
conditions
o
a DB, then compares
causing
only if there
inadequate
1.
Low profits
2.
Poor investment
returns
3.
Early
shortage
Pension
equivalent
retirement
equivalent
basis,
Can correct
for
DC accounts:
of DC account
actual
is a shortfall.
insurance
can be via annuity
costs.
425
Method
rates, actuarial
must be stated
in plan.
PANEL
DISCUSSION
EXHIBIT
15 (cont.)
FLOOR
o
Amount
of DC account
drawals,
employee
choices.
Almost
actuarial
valuation
considered
voluntary
always
PLAN
must reflect
contributions.
necessary
to create
investment
choices,
Employer
may limit
an imputed
account
with-
investment
for DB
purposes.
o
Benefit
subsidies
easy and automatic.
o
Employee
gets windfalls.
o
Difficult
to communicate
properly.
Uses:
o
To provide
o
To permit
o
As wraparound
plan with DC plan after
o
Add floor later,
if needed.
o
Combine with 401(k).
Special
o
minimum
benefit
Constraints
subsidies
and Legal
Floor plan funding
is funded
Special
under
in spite of poor DC experience.
at early retirement.
termination.
Requirements:
is ERISA,
as with any DB plan.
any of five methods
assumptions
DC (offset)
benefits
needed
and regular
to project
future
plan.
426
Anticipated
actuarial
contributions
benefit
assumptions.
and growth
in
THE
BETTER
ALTERNATIVE?
EXHIBIT
DEFINED
16
BENEFIT
PLUS 401(k)
Objective:
o
Frequently
pension
there is none.
The two plans are regarded
separately
as
plus savings.
Operation:
o
o
Two plans (two funds,
two documents,
Self
standing
DC plan
Self
standing
DB plan
Typically
DC plan enthusiastically
two everything):
received,
and DB plan not well
regarded.
o
Design
benefits
often
often
not done
with
retirement
benefit
adequacy
generous.
o
Has all the characteristics
o
Probably
the most common
of DB and DC
approach.
USES."
o
Competitive.
o
DB addresses
income needs.
DC addresses
427
buildup
needs.
in mind.
Combined
PANEL
Some of the plans
paragraph,
That
described
actually
doesn't
in the press, with the language
had the characteristics
mean this is bad plan
the minimums,
DISCUSSION
design.
that it's a good one.
-- even the target
plan.
described
I actually
I happen
to think,
good
why target
example
Hotel
know
of three
gives
where
In a hotel,
as quickly
them
quickly.
approach.
However,
you've
You don't
necessarily
want
plan might
Exhibits
usage,
target
plans,
what
in with
super
IRAs
happen.
while
is good
the future.
withdrawals.
level
employees.
You want
of young
for the younger
and
special
the
to leave
and turn
that
contribution
employees
who arc in and out.
level.
of all the different
today.
17). When looking
Consider
how the plan
The law may well be changed
or retirement
the population
defined
income
A target
was under
plans would
are about
Lower
worker
plans,
their
plans
instead
zero population
at plans, don't
you are designing
to restrict
contribution
is that demographics
Law may well be changed
workforce.
you a
constraints.
(Exhibit
The second caution
Demographics
had particu-
something
defined
got all kinds
FUTURE
o
tends
You want
high
If that happens,
contribution
probably
be appropriate:
a traditional
benefits
which
The clients
plan might
EXHIBIT
o
with
and were used. I'll give
your upper management
16 are descriptions
objectives,
I'd like to add two cautions
consider
especially
be a good idea for a hotel.
13 through
their
a target
as 3'our lower
a benefit
benefit
were appropriate
of a situation
del Coronado.
over just
plans
paragraph.
It's got its place, as do all the hybrids
puts me two or three above most people in this room.
lar reasons
of the first
in the second
simply
will
fit
pre-retirement
plans
might
of savings
plans.
be regarded
as
It could
are going to change.
For a
growth.
17
CONSIDERATIONS
to restrict
be regarded
to change
to retiree
pre-retirement
withdrawals.
Defined
as super-IRAs.
significantly.
ratio.
428
Higher
average
age