How Adopting Alternative Plan Designs Can Reduce Costs in a Defined Benefit Plan

Created by Kelly Knudsen, Modified on Thu, 5 Sep at 11:53 AM by Kelly Knudsen

Defined benefit (DB) plans offer valuable retirement security, but their rising costs due to market volatility, increased life expectancies, and administrative complexities have prompted many plan sponsors to consider alternative designs. Shifting to a more flexible structure can significantly reduce costs while still meeting employee retirement needs. Here are several ways adopting alternative DB plan designs can help lower expenses:

Hybrid Plan Options

A common strategy for reducing DB plan costs is shifting to a hybrid plan, such as a cash balance plan. Cash balance plans maintain the employer's responsibility for investment performance but offer employees a more predictable, account-style benefit structure. These plans allow employers to set fixed contribution rates and manage future liabilities more easily than traditional DB plans. By aligning contributions with a pre-determined formula, cash balance plans reduce the unpredictability tied to investment performance and employee longevity, helping control long-term expenses [1].

Lump-Sum Buyouts

Offering lump-sum buyouts is another way to reduce a DB plan's liabilities. By allowing plan participants to receive a one-time payout, employers can lower ongoing pension obligations. This strategy also helps mitigate the impact of interest rate fluctuations, which tend to increase liabilities in low-rate environments. Though there may be upfront costs, buyouts are an effective method for long-term savings, especially when market volatility or rising PBGC premiums are concerns [2].

Adjusting Early Retirement Incentives

Modifying early retirement incentives can have a substantial impact on reducing plan costs. Many DB plans offer generous early retirement options, which significantly increase plan liabilities by extending the payout period. Employers can reduce these costs by adjusting retirement age provisions or the reduction factors for early retirement. This encourages employees to work longer, reducing the number of years they collect benefits and easing the overall funding burden on the plan [3].

Pension Risk Transfer (PRT)

Pension risk transfer strategies, such as purchasing group annuities from an insurance company, allow plan sponsors to shift liabilities off their balance sheets. While this approach requires a significant upfront cost, it offers long-term stability and frees the employer from managing future investment risks and liabilities. In volatile markets, transferring these risks can ultimately be less costly than continuing to manage them internally [4].

Reducing Administrative Burden

Another cost-saving measure is to streamline administrative processes through plan design simplification. For example, merging multiple plans or consolidating vendors can lower fees and reduce the complexity of compliance oversight. Reducing administrative complexity not only cuts costs but also lowers the likelihood of operational errors, which can be expensive to correct [5].

Benchmarking and Re-Design

Finally, regular benchmarking of plan designs against industry standards is crucial. Through this process, employers can identify areas where they are overspending on plan administration or failing to maximize value. Adjustments to plan design, such as implementing automatic enrollment features or restructuring contribution formulas, can enhance employee engagement and retirement readiness, which in turn lowers long-term plan costs by reducing delayed retirements [5][6].

In conclusion, adopting alternative plan designs such as hybrid plans, lump-sum buyouts, and pension risk transfers, along with administrative simplifications and regular benchmarking, can provide significant cost savings for defined benefit plan sponsors. These strategies help employers maintain a sustainable retirement offering while keeping expenses under control.

References:

[1] USI Consulting Group. (2022). Reduce Costs and Increase Competitiveness with Retirement Plan Design. Retrieved from https://www.usicg.com/publications/insights-articles/defined-contribution-401k/reduce-costs-and-increase-competitiveness-with-retirement-plan-design/
[2] Verrill Law. (2023). Alternatives for Sponsors of Defined Benefit Pension Plans. Retrieved from https://www.verrill-law.com/benefits-law-update/alternatives-for-sponsors-of-defined-benefit-pension-plans
[3] SHRM. (2024). Six Ways to Reduce Pension Costs and Combat Volatility. Retrieved from https://www.shrm.org/topics-tools/news/benefits-compensation/six-ways-to-reduce-pension-costs-combat-volatility
[4] Milliman. (2023). Alternate Retirement Plan Design. Retrieved from https://us.milliman.com/en/retirement-and-benefits/alternate-retirement-plan-design
[5] Pew Charitable Trusts. (2017). Cost-Sharing Features of State Defined Benefit Pension Plans. Retrieved from https://www.pewtrusts.org/en/research-and-analysis/reports/2017/01/cost-sharing-features-of-state-defined-benefit-pension-plans
[6] USI Consulting Group. (2024). Benchmark Your Retirement Plan. Retrieved from https://www.usicg.com/retirement-plan-solutions/