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Remember the “three-legged stool”? That phrase was used for decades to describe Americans’ chief sources of retirement income: Social Security, private pensions and personal savings.
But in the 1990s and early 2000s, employers started freezing or eliminating defined-benefit pensions they had previously funded and replacing them with 401(k) retirement plans requiring employee contributions. As a result, the stool got wobbly. Today, just 15% of private employers offer pensions, compared with 35% in the early ’90s. About half of private-sector employees have a 401(k) plan.
Recent news of a new retirement benefit from IBM
IBM,
and growing interest by employers to help older workers convert 401(k)s into lifetime income at retirement, however, are making some analysts think pensions might start making a comeback in one form or another.
Read: What is IBM doing with its retirement plans? And why?
“We would encourage [retirement plan] sponsors to consider the numerous business reasons for keeping their [pension] plans open — or even reopening them, if closed,” wrote Jared Gross and Michael Buchenholz of J.P. Morgan Asset Management, in a January 2023 report, “Pension Defrost.”
Read: The appeal of annuities: people are willing to pay for products with lifetime benefits
If that happens, many employees will likely be enthusiastic. A striking 77% of Americans surveyed by the National Institute on Retirement Security in 2021 said all workers should have access to a pension.
When the United Auto Workers union picketed this year, its leaders pushed the automobile makers to reopen their pension plans to workers hired after late 2007. The companies refused.
Here’s what’s happening on the pension and lifetime-income fronts and what it all means for pre-retirees:
The IBM Retirement Benefit Account
When IBM, a longtime HR bellwether, came out with its 401(k) in 1984, many companies followed. After Big Blue froze its pension plan, other businesses did the same. That’s why analysts are wondering whether the tech giant’s latest retirement-plan move may be harbinger and why older workers across America may want to watch that space, too.
Read: Goodbye, 4% rule. Hello, 6% rule!
A leaked IBM memo revealed that IBM will in January stop its generous, dollar-for-dollar, 5% employee match in its defined-contribution 401(k) and start providing workers who’ve been there at least a year a new, portable, immediate-vesting pension called a “Retirement Benefit Account.”
That account, which analysts expect to be a cash-balance pension plan (which the SECURE 2.0 law of 2022 made easier to offer), will offer a 6% guaranteed, tax-deferred return for the first three years.
“I think 6% for the first three years is pretty good,” said John Lowell, a partner with the October Three Consulting retirement advisory firm in Woodstock, Ga.
From 2027 through 2034, IBM’s Retirement Benefit Account will provide a guaranteed return equal to the 10-year Treasury rate (currently roughly 4.2%).
By contrast, 401(k)s are typically far more volatile. That’s because workers usually put some of their contributions in stocks, making their retirement accounts subject to market fluctuations.
Because 2022 was such a lousy year for the stock (and bond) market, total returns for 401(k) participants over the past five years have averaged 4.2% a year, in Vanguard’s How America Saves study compared with 12.2% a year for the five years ending in 2021.
“Doing what IBM is doing takes that volatility away from employees on a piece of their retirement,” said Robert Massa, managing director of Qualified Plan Advisors in Houston.
The Retirement Benefit Account may also provide some peace of mind, since IBM retirees will get guaranteed income for the rest of their lives and know that the size of their accounts won’t dip even if the stock market does.
Without the match, however, IBM workers may be less inclined to save for retirement in their 401(k) plan, said Will Hansen, executive director at Plan Sponsor Council of America and chief government affairs officer of the American Retirement Association.
The Retirement Benefit Account’s locked-in returns could be trouble if inflation soars again, too, and retirees need to keep up with a rising cost of living.
Money in the Retirement Benefit Account might also not grow as much as it would were it invested in stocks. “Maybe you need to be more aggressive investing the money that is going into your 401(k) to strike that right balance,” said Hansen.
One reason IBM can offer this new pension is that the pension it froze is now overfunded, due partly to rising interest rates. Many pensions on the books at other big companies are similarly overfunded.
So, should workers look for their employer to mimic IBM and give them a similar pension to help bolster their financial security?
Possibly, but don’t count on it.
“When IBM said, ‘We are freezing our pension plan,’ it started a tidal wave” among employers, said Lowell. “I think companies are a little more apprehensive to follow IBM down this path with the Retirement Benefit Account.”
But, Lowell added, offering that type of pension could be a lure for employers to attract and keep workers.
“I had lunch with the CFO and controller of a client yesterday who has an ongoing defined-benefit plan, and they swear by it as an attraction and retention tool,” Lowell noted.
He’s getting a lot of questions from retirement advisers and HR executives asking about the new IBM pension.
“I think there will be some level of resurgence of pensions, but I don’t think we’re going back to 1985,” said Lowell.
Turning 401(k)s into lifetime income
However, more older workers may start seeing their employers offering not a pension exactly but something close — a way to convert some of their 401(k) balances into lifetime income once they retire, which many employees say they want.
“I talk to plan sponsors all the time, and ‘lifetime income’ is a buzzword,” said Hansen.
Today, retiring workers with 401(k)s typically either need to take their money as a lump sum, roll it over into an IRA at a financial services company or keep the account with the employer they’re leaving.
Only 10% of plans offer their retirees the ability to convert their 401(k)s into annuities that pay out monthly income for the rest of their lives, essentially mimicking a paycheck, according to the Plan Sponsor Council of America’s recent annual survey.
That’s up from 8% in 2021, which in the glacial world of employer retirement plan administration, “is a significant increase,” said Hansen.
Retirement analysts expect the percentage to keep creeping up because employers are increasingly being offered mechanisms to provide better, less expensive, more flexible and less complicated annuities than in the past.
“There has been way too much complication” in 401(k) annuities, said Prudential Retirement Strategies President Dylan Tyson at the Stanford Center on Longevity Century Summit in November. “The system has to make it easier, and we have to do what we can to keep costs low.”
Jessica Sclafani, senior defined contribution strategist at T. Rowe Price, said she believes retirement plan sponsors are evolving from an “exploratory stance” on retirement income offerings to a “decision-oriented” posture.
T. Rowe Price started offering employers a “managed payout solution” in 2019. But only in the past 12 months did 50+ plans begin providing the option to retirees.
“We are seeing the majority of defined-contribution plan sponsors proactively asking us about retirement income solutions,” she said. “They aren’t necessarily racing to implementation, but they are keen to understand the landscape. We’re still in the very early innings of implementation.”
Hansen said, “It almost seems like every other day we have a company announcing they have a new in-plan feature they are providing, which is getting more plan sponsors to think about offering a lifetime income product within their plan.”
Why the growing interest?
Partly, Sclafani said, it’s because America’s workforce is growing older. So, more people could benefit from converting some of their 401(k)s into monthly lifetime income in retirement.
Another reason: Employers want to stem the burgeoning outflows from their 401(k)s due to the rising number of workers who are retiring and rolling over their plan balances into IRAs. They want to hold on to some of those funds by letting retirees annuitize directly from their 401(k)s.
A 2023 T. Rowe Price survey found that two-thirds of plans want more 401(k) participants to keep their balances in the plans in retirement. “A decade ago, most plans were structured to actually kick retired participants out of the plan,” Sclafani said.
A small, but also growing, number of employers are looking into offering 401(k) annuities providing guaranteed retirement income for life. Some employers worry about the liability in choosing a guaranteed annuity provider.
“We do believe that guaranteed solutions will find a place within defined-contribution plans, however that’s just not where we see the majority of interest today,” said Sclafani.
Yet the Employee Benefit Retirement Institute’s 2023 Retirement Confidence Survey found workers with 401(k)s said “investment options that provide guaranteed retirement income” would be the most valuable improvement to their plan.
Tech and aerospace company RTX (formerly Raytheon Technologies) has offered a guaranteed-lifetime-income annuity known as the RTX Lifetime Income Strategy since 2012. Analysts think the flexible improvements the company just rolled out are interesting and could be replicated by other firms with 401(k)s.
According to the publication PlanSponsor, participants now can choose a target retirement age between 60 and 70 (rather than age 65, previously) and move just a portion of their 401(k) into the account (rather than all of it, previously).
Massa recommends older workers interested in converting some of their 401(k) into an employer’s retirement annuity and ask their company whether that option exists or if the firm could start providing it.
But, he cautions, don’t move all your 401(k) money into an annuity either through your employer.
Similarly, Massa added, don’t do so with an insurance company.
“I think there are plenty of unscrupulous individuals that will say, ‘You’ve got $290,000 in your 401(k); we need to put $289,999 in there. All they’re thinking about is their commission.”
