Alternatives to Frozen Defined Benefit Pension Plans
Originally Posted: August 28, 2009
Since their introduction in the 1980s, 401k plans and other types of defined contribution plans have become the primary means of retirement savings, leading many employers to freeze their current defined benefit plan and provide alternatives, such as a new defined benefit plan, a new defined contribution plan, or an enhanced existing defined contribution plan.
Defined benefit pension plans have played an integral role in developing retirement protection for millions of American workers. These pension plans have allowed retirees to secure monthly income for life, with payments based on service and salary. Such plans in the United States were initially developed to promote job stability and create a more career-minded labor force.1 Since their introduction in the 1980s, 401k plans--a type of defined contribution plan--have grown to become the a primary means of retirement savings, leading employers to replace their defined benefit plans with defined contribution plans for both current and new employees.
Many employers have opted to freeze their current defined benefit plan and provide an alternative. Alternatives available to employees include a new defined benefit plan, a new defined contribution plan, or an enhanced existing defined contribution plan.2 With the number of defined benefit plans steadily decreasing and frozen pension plans increasing, this migration could have major negative implications for those workers in the later stages of their career, where plan contributions may be at their highest. Employees are and will continue to be forced to reevaluate their retirement savings needs as employers alter their benefits package.
When a defined benefit plan is frozen, the employer may restrict entry into the plan and limit future contributions. The degree to which contributions and entry is limited will depend on the type of freeze. In some cases, an employee may stop accruing benefits in the event of a freeze, but the plan will continue in operation, protecting the benefits already accrued. Employers continue to make required contributions to fund accrued benefits.
BLS frozen plan data
The Bureau of Labor Statistics (BLS) recently began collecting data on frozen defined benefit pension plans, including details pertaining to the percent of workers participating in frozen plans, benefit accruals, and enrollment alternatives for employees in frozen plans. As chart 1 and table 1 show, data from the March 2008 National Compensation Survey (NCS) on employee benefits indicate that a fifth of all private industry workers participating in a defined benefit plan are affected by a freeze.3 A plan is considered frozen if the plan is closed to new workers or the plan ceased accruals for some or all plan participants.
Prior to the availability of the NCS data, information on frozen plans came mostly from a Government Accountability Office (GAO) study released in 2008. GAO found that about half of all plan sponsors in their study population had one or more frozen defined benefit plans. Overall, about 3.3 million active participants in the study population, who represent about 21 percent of all active participants in the single-employer defined benefit system, are affected by a freeze.4 The March 2008 National Compensation Survey benefits data show that 21 percent of private industry workers had access to a defined benefit plan and 20 percent participated in a defined benefit plan (See table 2). According to a 2005 study by the Pension Benefit Guaranty Corporation, the number of private sector defined benefit plans peaked in the mid-1980s at 112,000, compared with about 30,000 at the time of the study.5
The type of freeze will determine what restrictions are in place on the current pension plan. As chart 2 shows, among those workers enrolled in a frozen plan, the majority (76 percent) were in plans under a “soft freeze,” which implies that the plan is closed to new entrants, but all current participants continue to accrue benefits. Another 21 percent were under a “hard freeze,” which implies that a plan is closed to new entrants and current participants no longer accrue additional benefits. (See table 3.)
The remainder of this article concentrates on defining and discussing alternatives for those affected by a freeze in their benefit plan.
Of the private industry workers affected by a freeze, 96 percent had an alternative made available to them to help offset losses from their frozen defined benefit plan. Employees may be offered one of the following alternative retirement plans: a new defined benefit plan, an enhanced existing defined contribution plan, or a new defined contribution plan. (See table 4 for a detailed look into plan alternatives by worker and establishment characteristics and by wage percentiles.)
New defined benefit plan. As can be seen in chart 3, of all private industry workers participating in a frozen defined benefit plan, roughly 11 percent had a new defined benefit plan made available to them. Although this option is not common, workers in three groups--unions, large establishments, and the goods-producing industries--are given this alternative at a higher rate than other workers. Defined benefit plans tend to be more prevalent among union workers than among nonunion workers, which helps explain why private industry union workers participate in a new defined benefit pension plan at a rate that is 4 times higher than nonunion workers.6 Defined benefit plans place more of the responsibility on the employer, whereas with other retirement savings plans, the employees assume more responsibility and risk in managing their retirement funds.7
Among part-time workers participating in a frozen defined benefit plan, a very low percentage are offered a new defined benefit plan. According to the March 2008 National Compensation Survey benefits data, only 11 percent of part-time private industry workers had access to a defined benefit plan, 14 percentage points less than full-time workers.8 Part-time workers are more commonly associated with service occupations, lower wage jobs, and small establishments, as opposed to white-collar and blue-collar occupations, higher wage jobs, and large establishments, which tend to have more full-time workers. As a way to cut cost and divert risk, employers, especially those of small establishments, may reduce the availability of defined benefit pensions to part-time employees and instead, offer an alternative.
Enhanced existing defined contribution plan. Within defined contribution plans, contributions, whether they come from the employee or the employer (or both), are added to the employee's individual account. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans.9 Defined contribution plans require the employee to actively participate in building and maintaining their retirement savings.
As chart 4 shows, 31 percent of private industry workers affected by a defined benefit plan freeze are offered an enhanced existing defined contribution plan. Some employers may already have a defined contribution plan and can provide an incentive to those affected by a defined benefit freeze to switch to the defined contribution plan. Unlike the new defined benefit plan alternative, an enhanced existing defined contribution plan is more readily available to nonunion workers and workers within the service-providing industries.
New defined contribution plan. Participation in defined contribution plans has increased significantly over the years. Defined contribution plans have rapidly grown into the leading retirement savings option for private industry workers. Employers have continued to move forward with less reliance on defined benefit plans and more on defined contribution plans. Forty-three percent of private industry workers participate in a defined contribution plan, which is an increase of 8 percentage points when compared with 1992-93 data.10
Of the options that might be available to employees in frozen defined benefit plans, a new defined contribution plan was the most prevalent. As can be seen in chart 5, of the private industry workers whose defined benefit plan was frozen, 54 percent were given the option of a new defined contribution plan. This option was widespread across worker and establishment characteristics, most notably among part-time workers and in small establishments (1 to 99 workers).
For many, plan freezes have and will continue to have a major influence on how employees approach their retirement savings in the future. Although recent data from BLS show that workers affected by a freeze tend to have alternative plans made available to them, freezes in general consistently affect workers across industry and occupation. BLS will continue to track and research data regarding frozen defined benefit plans, with the intent of providing updated data annually.
1 Stephen P. McCourt, “Defined Benefit and Defined Contribution Plans: A History, Market Overview and Comparative Analysis,” International Foundation of Employee Benefit Plans, February 2006; available on the Internet at http://www.ifebp.org/PDF/webexclusive/06feb.pdf.
2 BLS currently collects data regarding enrollment alternatives for employees in frozen plans. Those alternatives include a new defined benefit plan, a new defined contribution plan, an enhanced existing defined contribution plan, or other. This article examines each of these alternatives except for “other.” For more information regarding other retirement plans that could be made available to employees in frozen plans, visit the Internal Revenue Service website at http://www.irs.gov/retirement/content/0,,id=111422,00.html.
3 The National Compensation Survey produces comprehensive data on the incidence (the percentage of workers with access to and participation in employer provided benefit plans) and provisions of selected employee benefit plans.
4 The Government Accountability Office conducted a study on defined benefit pension plan freezes and found that about half of all sponsors in their study population had one or more frozen defined benefit plans. Overall, about 3.3 million active participants in the study population, who represent about 21 percent of all active participants in the single-employer defined benefit system, are affected by a freeze. See Defined Benefit Pensions: Plan Freezes Affect Millions of Participants and May Pose Retirement Income Challenges, GAO-08-817 (Government Accountability Office, July 2008); available on the Internet at http://www.gao.gov/new.items/d08817.pdf.
5 An Analysis of Frozen Defined Benefit Plans (Pension Benefit Guaranty Corporation, December 21, 2005), p. 1; available on the Internet at http://www.pbgc.gov/docs/frozen_plans_1205.pdf.
6 NCS data show that 67 percent of Union workers chose to participate in a defined benefit plan in March 2008, considerably more than the 15 percent of nonunion workers. See National Compensation Survey: Employee Benefits in the United States, March 2008, Bulletin 2715 (Bureau of Labor Statistics, September 2008), table 2; available on the Internet at http://www.bls.gov/ncs/ebs/benefits/2008/ownership/private/table02a.pdf.
7 For more information on the various types of retirement plans, see “Retirement Plans, Benefits & Savings: Types of Retirement Plans,” on the U.S. Department of Labor website at http://www.dol.gov/dol/topic/retirement/typesofplans.htm.
8 See National Compensation Survey: Employee Benefits in the United States, March 2008, Bulletin 2715 (Bureau of Labor Statistics, September 2008), table 2; available on the Internet at http://www.bls.gov/ncs/ebs/benefits/2008/ownership/private/table02a.pdf.
9 For more information regarding types of retirement plans, see “Retirement Plans, Benefits & Savings: Types of Retirement Plans,” on the U.S. Department of Labor website at http://www.dol.gov/dol/topic/retirement/typesofplans.htm.
10 See Stephanie L. Costo, “Trends in retirement plan coverage over the last decade,” Monthly Labor Review, February 2006; available on the Internet at http://www.bls.gov/opub/mlr/2006/02/art5full.pdf.