DB(k): Not a 401(k), Not a Pension, Not a Bad Idea

It is rare to find this writer wrapping himself around anything that came from the mislabeled Pension Protection Act of 2006. I have criticized it at length and continue to find traces of this poorly written, business friendly piece of legislation that does little, if anything to protect pensions and a lot to shift the blame and the responsibility onto the employee.

But tucked away inside of the PPA is a little known, and possibly little cared for opportunity for small businesses to attract a higher quality worker through the benefit of a DB(k). What could this be?

In short it is a hybrid of sorts, a combination 401(k) plan and pension plan wrapped into one. Here's how it works (at least on paper):

Initially, you have to understand that part of the problem with retirement stems from the fact that 401(k) plans, the self-directed retirement plan that replaced the pension (defined benefit plan) were never designed to be the be-all-end-all retirement option. This is at the heart of our current problem. People were unprepared to become investors in many instances and refused in others to learn what they needed to know to become better at using the stock market to increase their wealth.

This (invested) wealth was supposed to shore-up retirement futures by investing in what appeared to be, even over the long-term, a sure thing. Although everyone was aware that stocks do not rise endlessly, over time, they rose enough to pique the interest of even the least savvy among us. You didn't need to be a rocket scientist to know that the act of simply putting money away in a tax-deferred account was all that was needed. Ignoring the rules of good investing was easy when you thought if your 401(k) plan as a savings account that provided bigger than life returns.

Although these folks failed to understand that these retirement accounts were actually investment accounts and not savings, the realization came too late. (Savings is what you put in a bank or CD, essentially money that is safe from loss and at the same time, earning interest.)

This doesn't mean that pensions were immune to the downturn. The people in charge of making sure that these plans were stable and low-risk, found the temptation to invest that money in greater amounts in riskier investments proved to be too much as well. What was supposed to be an economic stabilizer faltered. Because pensions were also hurt in the downturn, the PPA revealed its uglier side with rules that made many of these plans difficult if not cumbersome to continue. Less than 50% of the businesses now offer these plans.

We quickly came to realize that no corner of your retirement future it seemed was safe. There was no safe harbor.

So where does that leaves us now? Because "now" is a movable target, reliant on the strength of the economy and the recovery of the stock market, investors in their retirement future were left with two options: less risk or ignore the risk and get back in. Unfortunately, many are opting for less risk.

The DB(k) can change all of that by offering a stable side to the retirement picture while allowing the worker, specifically those at businesses with less than 500 employees, the chance to take risks they might not have taken otherwise.

The DB(k) is part pension giving the employer the opportunity to offer 1% of an employee's salary for every year up to twenty as a defined benefit. While this may not seem like the pension plans of yore, it is better than nothing and for the business itself, doesn't require them to shift funds to cover promises made.

The DB(k) is also a 401(k) plan. It has an automatic enrollment rule (which can be opted out of) that automatically stashes 4% of your pre-tax income in the plan. To encourage the employee without placing an outsized burden on the employer, matching contributions can be offered up to 50% of the employee contribution with a maximum set at 2%. Theoretically, the employee's participation in their retirement, including the employer match could be 7% of their income.

There is another part of the plan that could attract employers: work for three years and you are guaranteed a pension and the plan itself is not skewed towards the workers who make the most.

The added incentive for adopting such a plan is the ease of adoption and the low costs associated with it. If the employer opts to offer a plan that has lower costs (administrative fees) as well, the employee could see as much as 2-3% more money invested.

The only hold-up: the economy. As long as the recovery remains jobless, the incentive to change plans, which can officially be adopted beginning in 2010, will be slow. But once competition for new hires, particularly those looking for the best benefits possible increases, you can expect these plans will find a solid niche for employers.