A word of warning to 401(k) plans: Get ready to move over. Conditions may soon be ripe for traditional pension plans to stage a comeback, according to a new white paper from Pentegra Retirement Services.
The report argues that the economics that drove up the costs of defined benefit plans - the traditional pension plans of yesteryear - are showing signs of slowing down and reversing themselves. Historically low interest rates, the biggest culprit in the run-up in pension costs, "appear to have nearly hit bottom and are poised to now begin rising as soon as the Federal Reserve suspends the accommodative support of growth through an expansionary monetary policy," the report says.
In today's low interest rate environment, defined contribution plans hold a clear cost advantage over defined benefit plans. The typical DC plan cost is 5% to 6% of plan payroll versus 17% for the typical DB plan, according to Pentegra.
But with a rise in interest rates defined benefits plans would become more cost-effective very quickly. Interest rate increases of 300 to 400 basis points, roughly equal to rates that prevailed in 2006 - 2007, would not only decrease defined benefit pension costs by 30% or more but would give defined benefit plans surpluses of 115% to 125% of liabilities, Pentegra says in the report.
The 30-year bull market in bonds has also driven up the costs of defined benefit pension plans, but that too is expected to change as interest rates go up. An end to the bull market in bonds would increase the discount rate, which in turn would bring down long-term pension liability costs. Pentegra estimates that for every 100 basis points increase in discount rates plan liabilities fall by 12% to 14%.
"We firmly believe the defined benefit plan economics are shifting and will afford employers the opportunity for lower funding costs, thereby positioning defined benefit plans to once again become one of the most cost-effective methods of providing adequate retirement income to your employees," Rich Rausser, senior vice president of Client Services at Pentegra, said in a statement.
Pentegra Retirement Services is a provider of retirement plan solutions, including 401(k) plans and defined benefit pension plans, to organizations worldwide. It manages more than 3,500 retirement plans with over $8 billion in retirement plans assets.