The Middle Ground Between DB and DC

A study found hybrid retirement plans could provide adequate benefits to participants (if they tripled their savings rate) and reduce costs and risks for plan sponsors.

(October 9, 2013) — The success of future American pensions could reside in “hybrid” retirement plans, according to research by the Global Wealth Allocation (GWA).

Hybrid plans enter the pension scene at an interesting time, as employers have shifted from defined benefit (DB) plans to defined contribution (DC) plans. Their goal is to provide sufficient benefits without sponsors’ bearing the risk of salary-linked lifetime pension.

The move, which gives plan participants control over their own investment management, is bad news for most Americans, GWA said. They aren’t saving nearly enough for a comfortable retirement and fear another market crash. Also, today’s low bond yields could result in lower than expected returns.

The research stated that hybrid plans could be an answer to the big pension question.

Legally defined as modified DB plans, hybrid plans incorporate key features of both DB and DC plans: transparency, portability, professional asset management, controlled expenses, and lifetime income benefits.

GWA said while hybrid plans are clearly superior to DC plans, it is unclear whether they are better than DB plans.

Retirement benefits from hybrid plans are based on investments’ performance, the paper said. This also puts all or part of the investment risk to the participants, raising the question of whether hybrid plans could be a viable substitute for DB plans.

The research concluded that they could be, but only if contribution levels exceeded 15% of annual income for a “middle income” worker.

According to the paper, the median annual contribution of DC participants is around 5%.

One hybrid plan in place, the cash balance plan, grow benefits based on a specified annual formula and hold over $900 billion of assets, according to GWA. Another plan, the adjustable plan, provides a “floor level” benefit that increases over time as assets outperform liability funding rates.

Hybrid plans are good news for plan sponsors, the study says. By cutting costs to a sustainable and tolerable level, plan sponsors could focus on providing basic benefits and pinpointing long-term wealth generation opportunities.

Related content: Almost 25% of Irish DB Funds Will Be Gone By Next Year, Market Improvements Not Enough to Retire Comfortably in DC, DC Participation Peaks, But Savings Rates Still Falling Short

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