Feature – Benefits in America

In the US, defined benefit plans have been closing to new members for the best part of two decades, as firms push 401k defined contribution plans, says Jenny Keefe

If you read nothing else, read this …

  • The most popular pension in the US is the defined contribution 401k plan.
  • Defined benefit plans have been closing to new members for the last 20 years.
  • Employers pay premiums to the Pension Benefits Guaranty Corporation, which acts as a safety net for DB schemes.

Article in full

We watch the same films, shop at the same stores, and drink the same Starbucks coffee; now we are grappling with the same pension problems. As defined benefit (DB) plans close and more company schemes fold, the United States’ retirement woes have a familiar ring.

The 2001 economic downturn set the scene for a benefits cull, observes Brigitte Madrian, professor of business and public policy at the University of Pennsylvania. "In the late 1990s, there was a trend for employers to offer more novel, idiosyncratic niche benefits, for instance, free computers or concierge services. But as soon as the recession hit, companies yanked all of those benefits back."

US employers now concentrate on the twin diet of healthcare and pensions. "The biggest trend is the move away from DB and towards defined contribution (DC) style retirement plans," says Madrian.

Like the UK, the US offers DB and DC pensions. The most popular DC scheme is the 401k plan, where staff pay in their money, decide how to allocate it and bear all of the investment risks.

Closing DB schemes has been a long-standing trend. "The number of DB pensions plans that are in operation has been declining steadily for the last 20 years," says Madrian.

Public sector employers are much more likely to offer DB plans. Patty Gilbert, compensation and benefits manager for California’s County of Orange, says: "Government employers tend to be really paternalistic and watch out for employees." She adds that this accounts for the county’s low annual staff turnover of just 6%.

Nevertheless, Gilbert is concerned about the trend towards 401ks in the private sector. "All the money that goes into 401ks is subject to the stock market. So if you are in pretty aggressive funds, you could lose a lot of your nest egg. That’s what happened three years ago when the market took a dive. There were a lot of employees who were within a year of retirement and had to stay on."

The US is also facing the age-old problem of how to rescue company schemes that have collapsed. The Pension Benefits Guaranty Corporation (PBGC) is the model on which our own Pension Protection Fund (PPF) is based. All employers with DB schemes pay premiums into the fund, which makes up most of the shortfall when companies go bust.

But is this an example that we should be copying? As more companies file for bankruptcy, most notoriously United Airlines and US Airways, the PBGC is feeling the pinch. President Bush is expected to reform the system next year. "The PBGC does not have enough reserves to cover all of the pension obligations of the plans that have gone bankrupt and if more go bust, tax payers will end up footing the bill," says the University of Pennsylvania’s Madrian.

It’s not all doom and gloom though. One skill which our American cousins seem to have nailed is how to boost employee take-up rates. The amount of money that directors can pay into their own pensions is directly related to how much staff put in, which acts as an incentive to get more people on board. "It effectively penalises the highly paid employees if the firm doesn’t have high enough participation rates," says Madrian.