A return to old-fashioned pensions

I enjoyed reading this from Jenny Phipps of Banknote;

For many people, having an old-fashioned, defined benefit pension is a real retirement planning advantage. People who have them feel much  more financially secure, both as they plan for retirement and after they actually pull the trigger.

But in the last 20 years, the number of workers with defined benefit pensions  has declined, in large part because companies have been unsure about their  ability to pay for them as retirees live longer. Plus, returns on fixed-income  investments, which have been considered key to funding these plans, have been  historically low, at least for the last half-dozen years.

That’s all likely to change and defined benefit pensions will make a  comeback, predicts Rich Rausser, senior vice president of client services at  Pentegra, a retirement services company. Rausser wrote in a white paper:  “Underlying macroeconomic trends such as the 30-year bull market in bonds, the  decade-long stagnation in the equity markets and the lack of viable options to  extend duration for pension investment managers all exhibit signs of changing  for the better.”

Rausser says that in the current low-interest rate environment, the typical  defined contribution plan — such as a 401(k) — costs an employer about 6  percent of payroll. Meanwhile, the typical defined benefit plan today costs 17  percent of payroll. But it doesn’t take very long for the situation to change if  interest rates rise.

For instance, if interest rates go back to where they were in 2006 and 2007,  the typical defined benefit plan would have a surplus of 115 percent to 125  percent, Rausser calculates. That would allow plan sponsors to use these excess  dollars to fund the plans for several years without having to contribute  anything additional. That makes a defined benefit plan much cheaper than a  defined contribution plan where annual employer contributions are locked in.

So when will rates turn around and defined benefit pensions roar back?  Rausser doesn’t have a crystal ball, but he says some companies are already  anticipating that day. At least one of his large company clients recently  re-opened its frozen defined benefit pension plan. The company made that  decision after running the numbers and concluding that any expansion of a 401(k)  was already going to be at best cost neutral and possibly more expensive than  offering a defined benefit plan, especially when the company took into account  the cost of employee turnover, which defined benefit plans tend to reduce.

“The whole point of the white paper is that things are going to change  dramatically once rates go up, and we shouldn’t forget the impact of those  changes on pension funding,”

While this was written for an American audience, the impact of Jennie’s comments should not be ignored by those who set policy in the UK and those who sit on the Boards of the companies that are enrolling over the next three years.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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