January 1, 2006- The retirement security picture is bleak, especially for small and mid-size firms. Although they make up 98% of the nation's enterprises, more than 98% of the 40 million Americans employed at these firms lack the guarantees of a defined benefit pension plan. Worse, employers in most small businesses don't provide any retirement plan at all.
The Principal Financial Group and the American Society of Pension Professionals & Actuaries (ASPPA) have developed and taken to Congress a new hybrid retirement plan, called a DB(k) plan, to address this problem. It combines the best features of defined benefit and 401(k) plans and should be easy and affordable for small-business owners to offer.
Often, nondiscrimination testing makes it uneconomical for small businesses to offer 401(k) plans. An owner who offers a 401(k) can defer little compensation if the rank and file contribute little or nothing to the plan. Defined benefit plans, too, require employers to meet complicated rules about what funds go to key employees versus non-key. Moreover, compliance testing is usually cumbersome and expensive.
The DB(k) proposal exempts owners from these restrictions as long as they meet certain safe harbor requirements. On the defined benefit side, a DB(k) is not subject to top-heavy testing and funding rules if it guarantees a traditional benefit of at least 1% of average pay for 20 years of service. Alternatively, a sponsor could link the benefit to the employee's age (which also allows employees to take a lump sum if and when they leave the job).
For the 401(k) portion, the plan provides a safe harbor from non-discrimination testing if employers meet three criteria. The plan must combine an automatic enrollment feature with automatic deferrals that start at a minimum of 4% of compensation and increase by 1% a year; firms must match these deferrals at a rate of 50% up to the first 4% of compensation deferred; and the matching dollars must be 100% vested immediately. Employers can also apply the 401(k) match to an employee's defined benefit account to remove the market risk.
This plan offers numerous benefits for employers with fewer than 500 employees. It would let them sponsor a defined benefit program with more predictable costs and lower premiums, since the 401(k) matching specifications and the defined benefit payment formula are clearly spelled out. It's also affordable for employers launching a new plan because they would pay only a $5 premium per participant to the Pension Benefit Guaranty Corp. for the first five years, instead of the prevailing $19. Plus, the employer deduction limit would apply separately to the DB(k) and 401(k) portions of the plan, offering a greater tax advantage than two individual plans would afford.
Finally, a combined plan would be simpler to administer than two separate plans, requiring only one plan document, one Form 5500 filing, one summary plan description, one trust, one set of statements and one audit (if required at all).
Employees would also benefit from the DB(k) plan. Those whose companies match their deferrals with contributions to the defined benefit portion of the plan transfer the market risk of investing those funds to the plan sponsor, who guarantees them a specified rate of return. And the automatic enrollment provisions and salary-deferral increases mean that employees are likely to save more 401(k) dollars for retirement than they would have in a normal 401(k).
In November the Senate passed (by 97 to two) the Pension Security and Transparency Act of 2005, which contains the DB(k) proposal. The House will take it up next. Though the end product may be altered slightly, as long as it's a final provision in either chamber's pension reform bill, we'll be able to advance this important benefit plan.
We believe that DB(k) plans offer an important opportunity to help secure the futures of millions of Americans who lack retirement benefits today.
Rick Lawson is government relations vice president for the Principal Financial Group in Washington. Teresa Bloom is chief of government affairs for the ASPPA located in Arlington, Va. For more information regarding ASPPA, visit www.asppa.org.