Buried deep within the bowels of the Pension Protection Act of 2006 (pages 231-238 of the technical explanation) was a special provision that most folks don’t know about… this provision contains the framework of a new type of retirement plan. This new type of retirement plan is called a combination plan – meaning the combination of a defined benefit plan with a 401(k) plan. Don’t expect to find much written about it – there’s very little out there, in part because these plans aren’t set to become available until January 1, 2010.
The Combination Plan
A defined benefit plan is the IRS’s description of the old-style pension plan. And of course, we all know what a 401(k) plan is. So this new Combination Plan – referred to by many names, such as DB/k, Defined Benefit/401(k), or by the code section it comes from, 414(x) – is a safe-harbor version of both plans combined. With this type of plan, which is limited to employers of between 2 and 500 employees, the employer can provide the 401(k)-type of savings plan with prescribed matching, along with the old-style pension benefit (you remember, a percentage of your highest annual income, multiplied by your years of service, and all that?).
Being a safe-harbor plan means that there are prescribed percentages that the employer must follow in order to ensure that the plan maintains appropriate balances – such as matching at least 50% of the deferrals of the employee, up to 4%. In addition, the amounts prescribed for the DB portion of the plans are specific to the age of the employee, ranging from 2% for an employee aged 30 or less, up to 8% for an employee age 50 or better.
Although these amounts have been set forth by the law, it’s really not clear how the plan makes up the difference for employees… since an employee age 60 with 20 years’ time with the company, making $50,000 per year would have $4,000 credited to his account, somehow the account has to come up with a total of $10,000 (the 20 years times 1% times his salary) in annual pension payments when the employee retires. I suppose in time this will work out.
The Bottom Line
The bottom line for the DB/k in my opinion is that this is a nice plan, but it is likely to be 1) ignored, due to the complexity; or 2) dismissed altogether due to the costs. Either way, I wouldn’t expect to see a lot of DB/k plans in the industry, but I could be wrong. (Note: This likely accounts for the dearth of information available about these plans. Heck the IRS only asked for technical input on these plans a few months ago.) This sort of plan may be exactly what small employers have been looking for to make a difference and retain employees. I think that some sort of defined benefit (or rather, guaranteed income) component is likely to become an important part of retirement plans in the future, but I also believe that it will come as part of existing plans, such as low-cost annuities.
What do you think? Are you hearing a lot about these plans? Let me know in the comments section…