I know, defined benefit (DB) plans are dead. Actually, while there aren't as many as there used to be, I'm going to give you one more argument why they make more sense as a retirement vehicle.
Yesterday, I wrote about managing the risk in active pension liabilities. Way back in 2010, I wrote about generally managing risks and noted that plan sponsors tend not to manage defined contribution plan risks. Most of those risks that I have considered have been financial risk. Today, I am going to focus on the intersection of financial risk and compliance risk and make a case to have a DB plan as your primary retirement vehicle rather than a 401(k) plan.
In the world of 2015, we see consolidation in many industries. We also see companies, often private, being gobbled up by private equity firms. Either of these actions will usually create a larger controlled group. And, people who focus on retirement plan compliance know that most retirement plan compliance testing must be done on a controlled group basis.
Before working to point out a solution, let me give you an example to help focus on the problem.
BPE is a big private equity firm. Their general approach to retirement plans (and other benefits) has been to ignore them and let each company do what it wants. But, as BPE get bigger, its controlled group gets more complex. Having multiple industries represented in its portfolio, BPE is ultimately the sponsor of all kinds of 401(k) plans. Their engineering company (EC) has an extremely generous 401(k) plan that matches 150% on the first 8% of pay that an employee defers. Their pork rinds company (PRC) has a 401(k) plan that matches 10 cents on the dollar on the first 2% of pay that an employee defers.
BPE never saw this as a problem. But, then one day, an inquisitive Principal (IP) at BPE was reading my blog (of all things) and came across this. He saw that BPE might have a compliance problem in its controlled group because of the disparate nature of its 401(k) plans.
Ring ring ring -- that's my phone as IP calls me. He wants to know how to fix the problem. He says that surely this problem can't be real. After an hour on the phone, we have inventoried all the plans at BPE and found that they have failed to satisfy various compliance tests (coverage under Code Section 410(b), for example) for several years.
IP has a solution though. He tells me that BPE will force some of its companies to retroactively cut the employer match in some of these more generous plans.
You can't do that. In fact, if BPE were to choose to fall on its sword and approach the IRS for a negotiated retroactive solution, we would suspect that the IRS would only be receptive to increasing benefits for nonhighly compensated employees (NHCEs) in the less generous plans.
IP is not happy about this. PRC runs on very low margins, but because they make more pork rinds than any company in the world, they do throw off a lot of cash. However, increasing benefits would eliminate most of that free cash that is being generated. There is stunned silence on the other end of my phone.
While the story is fictitious, the gist of the scenario is not. I've seen this happen. By being a serial acquirer, companies run into compliance problems and with 401(k) plans not being the easiest to prove nondiscriminatory, either costs escalate or they get cut at the portfolio companies that tend to employ more higher paid individuals.
What sort of plan tests better? A few weeks ago, I wrote about some. Suppose BPE had a defined contribution looking cash balance plan. One of the nice things about these plans is that they test well. Designed properly, and proper design truly is a key, financial risk is manageable. And, with that as their primary plan, the secondary 401(k)s can be managed so that compliance there will no longer be an issue.
Unfortunately, the benefits world has been resistant to this whole concept. But, you have an open mind, don't you?
We need to talk.