IMPLICATIONS OF TRANSITION FROM DB TO DC PENSION PLAN 2

Implications of Transition from Defined Benefits to Defined Contribution Plans
Defined benefits (DB) and defined contribution (DC) plans are the two most common
pension plans that are used by employers. Defined pension plans are plans where the employer
provides specific level of retirement to a employee (Milkovich, Newman, & Gerhart, 2016). The
retirement pension provided by the employer is expressed as a percentage of the employees
earnings which often increase with years of seniority. The employer could also provide fixed
dollar contributions. As for defined contribution plans, employees have a retirement benefits
account in which employers make contributions to (Milkovich et al., 2016). 401 (k) and 403 (b)
are some examples of defined contributions. For a long time the defined benefits plan was the
dominant plan. However, the past thirty years have witnessed a slow but steady movement from
defined benefits pension plans to defined contribution plans (Milkovich et al., 2016). The
transition has particularly been pronounced in the private sector where in most countries and
sectors, defined contribution plans are now more than defined pension plans. This transition has
major implications for both employees and employers.
Factors contributing to transition from DB to DC
Defined pension plans generally provide employees with superior retirement income than
defined contribution plans. However, despite this benefit, it is slowly being phased away in favor
of defined contribution plans. There are many reasons that explain this transition. One of them is
increased cost of DB plans. Ageing populations mean that people are living much longer after
retirement than it was in previous years. As a result of this increased longevity, employers are
having to spend more under the DB plans (Milkovich et al., 2016).

IMPLICATIONS OF TRANSITION FROM DB TO DC PENSION PLAN 3
Another factor contributing to the transition is change in composition of industry
(Milkovich et al., 2016). DB plans are particularly popular with heavily unionized industries
such manufacturing. In fact, some of the biggest DB plans were for sectors such as auto
production, steel, and coal. The past thirty years have seen steady decline of these industries. As
they have declined DB plans have also declined.
Apart from decline of manufacturing sector, regulatory and tax changes have also
contributed to the decline of DB plans. For instance, the US passed the Employee Retirement
Income Security Act (ERISA) in 1974 which brought in many pension rules and regulations
(Milkovich et al., 2016). Over time, these rules and regulations have become both costly and
complex to implement when administering DB pension plans. Organizations, therefore, do not
have the incentives to continue with DB plans.
Lastly, the past three decades have seen significant increase in workforce mobility. This
increased mobility has been a result of factors such as changes in labor force demographic
composition and technological changes (Milkovich et al., 2016). DB plans generally favor
employees who stay in one organization for long and retire while working for the organization.
Under DB plans, employees who change jobs many times in the course of their careers are,
therefore, at a disadvantage. Since DC plans are entirely portable, they are preferred by
increasingly mobile workforce who have to frequently separate from their sponsoring
organizations.
Current implications of transition from DB to DC on employees and employers
The increasing transition from DB to DC has significant implications for both employers
and employers. When considering the impact of DB to DC transition on employers, it is

IMPLICATIONS OF TRANSITION FROM DB TO DC PENSION PLAN 4
important to remember that benefits plan constitute a liability to employers. Having guaranteed
their employees a certain amount of pension, they have to make sure that they manage their
employees finances prudently so that they deliver on their promise. DC plans ‘free’ employers
from such responsibility. All they have to do is contribute to the employees pension account. The
main disadvantage of this transition for employers is that they may no longer use generous
retirement benefits as a tool to keep employees working in their company for long.
As for employees, transition to DC plans has reduced “accrual risk”. This is the risk of
having less retirement income as a result back loading of DB plans. As a result, they can freely
hop from one job to another. Unfortunately, the transition to DC plans has led to movement of
risk from employers to the employees themselves or their financial advisors. Their retirement
income is, therefore, dependent on their financial prudence, prudence of their financial advisors,
and performance of financial markets (Milkovich et al., 2016). In terms of poor economic
performance such as was the case during the Great Recession of 2008-2010, their retirement can
shrink significantly.
Future implications of movement from DB to DC plans on employees and employers
Movement of pension plans from DB to DC will have major implications to employees as
well as employers in future. Employees will have to bear more responsibility for their retirement
savings investment. Transferring investment risk to employees may result in many employees
retiring with a much smaller income than they would have had under the direct benefits plan
because of poor investment decisions. Additionally, many employees may choose to delay their
retirement. This is especially the case with employees whose retirement time coincides with
periods of poor economic performance. As for employers, they will enjoy less costs of
administration of their employees retirement plans. This may result in greater profitability.

IMPLICATIONS OF TRANSITION FROM DB TO DC PENSION PLAN 5
Solution to the problem
It is clear that defined contribution has significantly more risks for employees than the
defined benefits plan. Employees risk losing all their retirement earnings in bad investments.
During times of economic downturn when financial markets perform very poorly, the risk of
losing one’s retirement earnings is particularly great. However, defined contribution plans also
have the advantage of allowing for greater labor mobility which is increasingly becoming
common. It, therefore, cannot be completely be done away with. My proposed solution to the
problem of risk associated with defined contribution plan is for employers to have age-related
adjustments to their employees retirement plans. For younger employees, organizations should
adopt direct contributions plan. Younger employees are likely to hop from one job to another.
Thus, they will find the direct contribution plan advantageous. For older employees, such as
those above forty five, employers should use direct benefits plan. With a few years to retirement,
older employees are unlikely to change employers. Additionally, they are more likely to
appreciate a retirement plan whose value is not affected by performance of financial markets
because they prefer a more stable plan.
Another solution is to teach employees financial management and how to make sound
investment decisions. With responsibility of managing one’s retirement money taken from
employers to employees, it is important that employees receive proper training in management of
finances so that they do not make decisions that would condemn them to a life of poverty and
hardship in their retirement years.

References

IMPLICATIONS OF TRANSITION FROM DB TO DC PENSION PLAN 6
Milkovich, G. T., Newman, J. M., & Gerhart, B. (2016). Compensation. McGraw-Hill Higher
Education.