For the past 20 years, there has been a clear trend in retirement benefits offered by companies. Investment risk has steadily shifted from the employer to the employee. Decades ago, most employers that offered benefits did so via defined benefit or pension plans. These plans guaranteed a certain income stream to retirees. Defined benefit plans provided employees with security, which helped fuel loyalty.
But as demographic changes and medical advances increased post-employment lifespans, these plans became prohibitively expensive for many companies to offer. Since the payments continued for life, the longer people lived the more expensive the plans became for companies.
At the same time, employees increased their appetite for risk, driven by the lure of high returns generated by the equity markets. Deregulation also created opportunities for new retirement investment types.
Enter stage right: the defined contribution plan.
With a defined contribution plan, employees direct a portion of their wages into an investment account. In many cases the employer also contributes a specific amount into the account. These proceeds are then invested. When it comes time for the employee to access the funds for retirement, their reward is limited to whatever is in the account. The employer has no further obligations.
Defined benefit plans have all but disappeared among private sector employers. But given the volatile performance of the stock market over the past decade, the grave uncertainty that exists over the Social Security and Medicare programs, and the shell shock from the Great Recession, high-potential employees and top candidates are now asking for defined benefit plans to make a comeback.
According to a recent survey by Towers Watson, 60 percent of recently-hired employees at companies that offer defined benefit plans indicate that having a pension plan was a key factor in choosing their employer. This is more than double the 27 percent that felt that way in 2009. Offering a defined benefit plan is clearly a powerful tool for recruiting.
The same study also indicates that offering a pension plan helps with retention rates. Seventy-two percent of employees at companies with a pension plan state that it is a key reason for staying. When asked about defined contribution plans like 401(k)s, only two out of 10 employees indicated it was a factor in choosing their current job with less than three out of 10 indicated it is a reason for staying.
Is it worth it?
Offering a defined benefit plan can be very expensive. It’s a matter of determining if the costs outweigh the benefits. The challenge is that many of the benefits, while valuable, are difficult to quantify. Calculating the return on investment can be tricky and the results may be too subjective to be meaningful.
- Savings from lower turnover
- Savings from reduced recruiting
- Savings from substitute benefits that can be eliminated
- Increased productivity from more satisfied employees
- Savings from closure of defined contribution plan
- Transition costs from existing defined contribution plan
- Plan set-up costs
- Plan maintenance costs
With unemployment remaining well above nine percent for the foreseeable future, it hardly seems pressing to many business owners to consider offering additional, costly benefits. Just getting a paycheck seems to be enough to convince someone to join. But if your business is in a competitive industry that requires individuals with unique skill sets, then it may be worth conducting a thorough evaluation of switching to a defined benefit plan. The unemployment rate will go down eventually. When it does, you don’t want to experience a mass exodus of talent.
Mike Periu is the founder of EcoFin Media, LLC which develops financial training, financial education, entrepreneurship training and more to small business owners on television, radio, print and the internet. Over the past ten years he has started three companies and advised over 50 companies on financial strategies including fundraising. Post your questions in the comments of this article.