Over the last year it's become abundantly clear that the stock market can devastate even seemingly healthy retirement accounts. Even so, with the guaranteed income of traditional pensions disappearing, most investors have little choice.
The vulnerabilities of the 401(k) plan have cast doubt on whether a voluntary savings plan is the best way for workers to prepare for retirement. There are some possible alternatives coming, however, that might just catch on. One that may become available in January offers a guaranteed pension-like retirement benefit alongside a 401(k).
It's called the DB(k) and it was created in the tax code in 2006. The law allows companies with fewer than 500 workers to start the hybrid plan after Jan. 1, 2010, and some proponents would like to see it available to all workers. As it is now, barely 40 percent of all workers even participate in a retirement plan at work.
Here are some questions and answers that explain details of the DB(k):
Q: What are the basic features of the DB(k)?
A: There are two components to the plan:
Companies will be required to establish a pension fund sufficient to pay a worker in retirement up to 20 percent of that individual's average annual pay received during the last few years of work. After three years with a company, a new employee's benefits will be vested. This means the money is theirs even if they leave the company. Their balance in this account would be paid out at retirement in monthly checks like a traditional pension plan. Such plans are called defined benefit plans, which explains the DB part of the DB(k) name.
Alongside that benefit, the company will automatically take 4 percent of a worker's pay and put it in a 401(k) plan. The company must match 50 percent of that amount, which would be immediately vested. At retirement, the worker could withdraw additional funds from their 401(k) account to supplement the pension payments. Workers can opt out of their contribution or chose to set aside less.
Q: What's the reason for creating a hybrid pension/401(k) plan?
A: The DB(k) was developed by the American Society of Pension Professionals and Actuaries, and Principal Financial Group Inc. More companies are dropping pension plans and workers with a 401(k) often do not save enough, leaving U.S. workers woefully unprepared financially for retirement. A recent study by The Center for Retirement Research at Boston College concluded that 51 percent of households likely will not have enough money in retirement to maintain their lifestyle, up from 44 percent in 2007.
The DB(k) idea allows companies to provide the benefits of a combined plan without onerous paperwork, regulatory requirements and costs that would come with operating the two plans separately, said Chris Mayer, a Principal Financial Group vice president. Workers get a more secure retirement with the guaranteed pension alongside their own savings.
Q: What types of companies would want to offer a DB(k) and why?
A: Companies must have at least two employees and cannot have more than 500 workers to implement a DB(k) plan. These plans are most likely to be offered by companies looking for professional workers in competitive fields — those who feel they need to offer this enhanced retirement plan to attract the best in their field or keep workers from going to a competitor, said Jan Jacobson, a spokeswoman for the American Benefits Council. Law firms and accounting companies are a couple of examples.
Employers must completely fund the pension and provide matching contributions in the 401(k) plan. As a result, those adopting this plan need adequate cash to pay the cost, which Principal Financial's Mayer estimates to be about 6 to 8 percent of payroll. That's less than companies with separate pension and 401(k) plans pay now, he said. So, companies currently managing both a pension and a 401(k) might consider the new plans to reduce costs and paperwork.
Q: How soon are we likely to see DB(k) plans launched?
A: The DB(k) is authorized by the Pension Protection Act of 2006, which authorizes companies to begin offering the plans starting on Jan. 1. However, the Internal Revenue Service and the U.S. Treasury only recently began developing rules for the plans, so adoption may be delayed until later next year. Still, the retirement services industry expects interest to increase once the economy improves and competition for workers intensifies.
Q: How can I find out more?
A: A few organizations, law firms and accountants have set up Web sites to provide information about the plans. If you want to do further research, you can find information by searching "DB(k) plan." The government frequently refers to the plans as "eligible combined plans" in its documents. You may also find some information under the IRS designation 414(x), which is the section of the tax code relating to the retirement accounts. The IRS details the plan here.
Many details about the practical operations of DB(k) plans will not be known until the IRS and Treasury officials complete and publish the final rules, which could affect the number of interested companies.