IBM saves billions by reopening its pension plan – Could other companies do the same?
After decades of pension freeze, hibernation, and risk transfers, could the great pension defrost be next?
What did IBM do?
International Business Machines Corporation (IBM) is one of the largest sponsors of a defined benefit (DB) plan in the United States. It has been ranked #1 for many years in Milliman’s Corporate Pension Funding Study of the 100 largest corporate pension plans in the United States (dropping down to #4 in 2023 after completing a large retiree buyout). As such, it is one of the industry leaders within the retirement benefits space.
Recently, IBM made huge news in the industry when it announced a major change to its retirement benefits strategy. Over the past decade IBM has made 5% matching contributions into its employees’ 401(k) accounts. Starting in 2024, however, it will fund a 5% credit into a “Retirement Benefits Account” for each employee. The “Retirement Benefits Account” is a cash balance plan, a type of DB pension plan, which IBM will create within its legacy frozen pension plan. This means that IBM has reopened its pension plan! It reverses the trend seen in the past two decades of companies closing DB plans and switching to 401(k) plan designs and may signal an industry turning point for retirement benefits spending in the United States.
What is a cash balance plan?
A cash balance plan is a “hybrid plan.” It functions much like a defined contribution (DC) plan, in that a balance is tracked for each employee that increases each year with salary credits (like company contributions) and interest credits (like investment earnings). However, interest credits are defined by the plan document (e.g., IBM is granting 6% interest for the first three years and interest related to the 10-year Treasury yield in years thereafter). Also, employees are given the option at retirement of converting their cash balance account to a guaranteed lifetime annuity for them and their spouse. For more information on cash balance plans see Cash balance plans: Frequently Asked Questions.
How does this affect employees?
As with all changes, this switch involves trade-offs. Whether or not this is a positive change will be viewed differently by each employee depending on their individual circumstances.
Figure 1: Pros and cons of IBM change on employees
| Pros | Cons | No change |
|---|---|---|
| Employees gain access to a lifetime annuity to protect them from the risk of outliving their savings. | Employees don’t get to pick how their cash balance account is invested. | Account balances are still fully portable if the employee leaves IBM for another employer. |
| Interest credits are guaranteed, and employees’ balances will never decrease, even in market downturns. | Interest credits in a cash balance plan are often lower, on average, than investment returns that could be achieved through long-term investing in the equity market. | Employees can increase risk exposure in other retirement accounts due to the low-risk cash balance benefit, resulting in the same total risk profile. |
| The full 5% salary credit is guaranteed every year even if the employee can’t contribute to their 401(k) account that year. | The removal of matching contributions may result in fewer employees electing to contribute into their 401(k) plans. | Employees can continue to make tax-deferred contributions into their 401(k) accounts. |
Why might IBM have made this change?
There are several reasons why IBM may have made this change.
From a human resources (HR) perspective, IBM may have felt that a cash balance plan benefit would help set it apart from competitors. The promise of guaranteed lifetime annuity retirement benefits is rare, so that might help IBM recruit and retain talent. Traditional defined benefit plans were abandoned due to the risk burden they placed on employers, but legislative changes, new plan designs, and new investment strategies allow employers to mitigate these risks while still providing lifetime benefits to employees. For more information on this see The big thaw: Why now is the time to consider unfreezing your defined benefit plan.
From a finance perspective, IBM will likely have significant cash savings in both the short term and long term due to this shift.
How is this going to save IBM money?
IBM’s legacy pension plan has been closed for nearly the past two decades; during that time, it has become significantly overfunded. According to IBM’s 2022 annual filing (10-K), its U.S. pension assets exceeded liabilities by $3.6 billion. Pension law prohibits IBM from tapping into this surplus to help cover the cost of DC benefits like 401(k) matching contributions. However, because a cash balance plan is legally considered a defined benefit plan, IBM is allowed to use these excess assets to fund cash balance benefits. IBM made about $550 million in employer contributions into its 401(k) plan in 2022. By switching to a cash balance benefit IBM can now use that $3.6 billion of excess assets to cover the cost of these annual contributions.
This means that it could be five to 10 years before IBM has to start making cash contributions again toward funding employee retirement benefits!
Even once the excess assets are used up, IBM’s contributions will likely be lower than they would have been with the 401(k) plan. This is because any investment returns that the plan earns above the cash balance interest credit rate go toward reducing future plan sponsor contributions. For example, if the interest crediting rate is 3% each year, and the plan earns 5% average investment returns, then IBM could fund the 5% salary credits with contributions that are closer to 4% of payroll.
Can other companies see savings like this?
Yes! There are hundreds of companies across the United States with overfunded legacy pension plans. For example, of the other 99 companies in the Milliman 2023 Corporate Pension Funding Study, 27 of them have closed plans with excess assets. Combined, these excess assets total over $27 billion.
If each of these companies mimicked IBM’s retirement spending strategy and reopened their frozen plans, adopting a cash balance design (or any other type of hybrid DB plan), that could free up $27 billion in cash over the next decade to be invested in other company initiatives or given back to shareholders!
Given the improvement in funded status in 2023 (see the Milliman Corporate Pension Funding Index), there are likely even more companies with surpluses at this point.
Of course, numerous items need to be considered prior to making such a major change in employee benefits strategy. For example:
- Cash balance plans are just one type of hybrid DB plan design. Another option is variable annuity plans. These plans can provide lifetime benefits to retirees without exposing the company to significant investment risk.
- Companies do not need to move the entire 401(k) matching contribution into a DB benefit like IBM did. Another option would be to just reduce the matching contribution and add a DB benefit to make up the difference. This would allow the company to access surplus assets in the DB plan, while still maintaining the advantages of 401(k) matching contributions.
What are the risks to a change like this?
Historically, the most significant risks for defined benefit plans are investment and interest rate risk. These are two of the reasons that most companies moved away from traditional DB plans over the past few decades. When investments returns were low or interest rates fell, then liabilities would outgrow assets, requiring the companies to recognize a pension liability on their balance sheets and make extra contributions to make up the deficit.
However, modern plan designs and investment strategies can be used to greatly mitigate these risks. In addition, legislative changes over the past decade have given employers much more flexibility in pension plan contributions. That being said, there are always risks to any benefit design (DB or DC), so companies should consult with retirement plan specialists before making any changes.