IBM Strives for the Security of Defined-Benefit Programs as It Shifts Focus to 401(k)s

    "In some respects, we are redeveloping the defined-benefit plan and making it better," says Jim Rich, chief investment strategist at IBM Retirement Funds.

    As more companies move away from defined-benefit plans to 401(k)s, many are finding themselves in a new dilemma. While they are happy to have rid themselves of the costs and liability issues associated with defined-benefit plans, they want their new 401(k) plans to offer the same kind of security. From adding automatic enrollment to features that help employees secure income after they retire, many employers today are struggling with how to guarantee that their employees have enough to retire without being responsible for putting up the money themselves.

    Already this year IBM has added automatic enrollment, automatic rebalancing, disability insurance and an annuity income option that allows retirees to receive guaranteed payments over the course of their lives. The company has increased the match to new employees--it’s now 6 percent rather than 3 percent. IBM is also considering offering two more features: automatic step-ups, which would increase employees’ contributions periodically, and a managed account feature, in which the company would contract a financial adviser to manage the assets of an employee for an additional fee.

    An increasing number of 401(k) plan providers have added managed account options to their plans in the past several months because they recognize that employees often need help with investing their retirement savings. IBM, however, is thinking about doing it a bit differently. The firm is discussing offering managed accounts as the default option in its plan, which would mean that employees’ contributions would automatically be swept into a managed account unless they opt out.

    IBM and other employers that have moved from defined-benefit to defined-contribution programs are turning to automatic features to help employees have enough assets to retire. Features like managed accounts offer the hand-holding that employers liked about traditional defined-benefit plans without the liability and cost issues associated with them, consultants say.

    IBM has an 89 percent participation rate in its 401(k) program, but the company has loftier goals than having a high 401(k) participation. Since its employees tend to retire at age 60, IBM wants to make sure that they can keep doing so, Rich says.

    "When I go to the doctor and something is bothering me, I don’t expect him to hand me a manual," he says, adding that he does not think it is fair to assume that employees are investment-savvy, even if they do participate heavily in the 401(k) program. "This is a very complicated thing."

    IBM does offer a financial asset allocation tool online as part of a partnership with Financial Engines, but these services only tell investors what kind of funds they should choose. They do not recommend specific funds. "If employees ask which U.S. stock fund they should invest in, we can’t tell them," Rich says.

Fee concerns
    Employers largely have been hesitant to offer managed accounts as the default. They recognize the value of offering financial advice to plan participants, but sweeping them into a program in which they would have to pay an added fee--which usually ranges from 15 to 30 basis points on top of the fund expenses--could lead to backlash from employees and raises liability concerns.

    "We are exploring this option with outside counsel," says Brock Johnson, vice president at Morningstar Associates, which teams up with fund companies to offer a managed account program to 401(k) plan sponsors. Johnson says that all of Morningstar’s fund-provider partners are examining the issues of offering managed accounts as a default, but none of their clients are doing it yet.

    "I certainly think it’s going to be something that will be used," he says. While 21 percent of 401(k) plans offered managed accounts in 2003, up from 12 percent the previous year, it is "very rare" for an employer to offer this as a default, according to David Wray, president of the Profit Sharing/401(k) Council of America, a national, nonprofit association of 1,200 companies.

    IBM, however, may have found a solution to the fee issue, Rich says. IBM is considering offering tiered pricing for managed accounts. Under the concept, employees would be automatically enrolled into a managed account program using a couple of IBM’s four "life strategy funds," which are funds that invest in collective trusts. The funds have expense ratios ranging from 11 to 16 basis points, and the added fee to the employee would be just 10 basis points. As with its current automatic enrollment program, employees would be able to opt out.

    Once employees gain more assets and get more comfortable with the program, they could opt for a more complete managed account, which would offer financial advice and management based on all of their assets, for around 30 basis points, Rich says. Before making a decision on offering managed accounts, IBM wants to make sure the cost is worth the advice. "Fees are one thing, but we also need to look at how good the advice is, and that requires a lot of due diligence," Rich says.

    IBM is in a good position for a test run because its own funds have such low fees, says Silvia Frank, manager of the defined-contribution plan at Trinity Health, a health care provider based in Novi, Michigan. The average fee for retail lifestyle funds can range from 25 basis points for index funds to 85 basis points for actively managed funds, according to Hewitt Associates.

    "IBM is in a great position to do this because their fees are so conservative," Frank says, noting that these low fees are "not typical." She says that the challenge IBM may face if it goes through with offering tiered pricing is getting employees to understand it. "It’s all going to be in the communication," she says.

Making the money last
    While offering managed accounts may help employees accumulate enough assets for retirement, IBM’s new annuity feature is designed to help plan participants have enough income after they retire. "The big risk we all face when we retire is, what if we live too long?" Rich says.

    Under IBM’s new program, which was designed by Hueler Cos. of Eden Prairie, Minnesota, employees can go to a Web site, input their age and marital status and within a day receive a list of price quotes for fixed annuities. Rich says that having insurers bid for the business of an employee solves one of the main problems with offering annuities: the costs. Also, since these annuities are institutionally priced, they end up costing "tens of thousands of dollars" less over the duration of the contract, he says. The costs of an annuity are taken out of the employee’s payments and thus vary on a case-by-case basis. Hueler takes a 1 percent fee.

    Along with the quotes, employees can view the credit ratings of the insurers and contacts for more information. Employees can opt for step-ups of 2 percent to 5 percent to make sure their income payments stay ahead of inflation. The feature also allows employees to pay extra to establish guarantees in the case of death.

    For example, if the employee opts for a "five-year certain," it would mean that the family would receive income for the next five years after the employee’s death. IBM is offering guarantees for five-, 10- , 15- and 20-year periods. After choosing the annuity they want, employees then roll over their retirement assets into an IRA account, which is invested in an annuity so that IBM has no fiduciary liability over those assets, according to Rich. "It becomes the decision of the employee," he says, noting that IBM offers credit ratings to assist with that decision.

    The fiduciary liabilities involved with offering annuities are a major reason that 401(k) plan providers have backed away from these options, Wray says. IBM, by offering the annuity option outside of its plan, solves this issue and takes out the cost concern, he notes.

    While employers are discussing how to make sure their employees have enough to retire, ensuring that they have enough to last the rest of their lives is just an emerging concern, notes Martha Tejera, consultant and principal at Mercer Human Resource Consulting. "I think IBM is out in the front, and I would like to see other companies doing this as a distribution option," Tejera says.