How IBM Reopened Its DB Plan To Replace 401(K) Contributions

Executive summary:

  • Starting in 2024, IBM will replace its 401(k) plan matching contributions with a new benefit earned within its overfunded DB plan, which has been frozen since 2008. This move essentially un-freezes the tech giant's DB plan.
  • Until now, pension surplus has not typically been utilized by plan sponsors to fund new benefits. Doing so completely changes the return needs and risk considerations for a fully funded plan. It also impacts the design of any glide path in place.
  • It's unclear whether IBM's decision could mark the start of a small trend away from 401(k) plans and back to DB plans among U.S. corporations. However, we believe IBM's decision will likely cause sponsors of fully funded plans to reconsider their strategy.

IBM, one of the largest defined benefit (DB) plan sponsors in the U.S. and fifth-largest in our ongoing $20 billion club research, recently made a landmark change to its employee retirement benefits. In 2024, they plan to replace their 401(k) plan matching contribution with a new benefit (ostensibly of similar value) kept within their legacy (and overfunded) defined benefit (DB) plan. This change is noteworthy since it bucks a trend from the last 40 years of transitioning from DB to 401(k). With this change, for once, 401(k) takes a back seat to DB. Moreover, this DB plan has been closed to new participants since 2005, and benefits have been frozen since 2008. This move essentially re-opens (i.e., un-freezes) their DB plan, albeit with a different benefit than the legacy participants once received.

Why now?

Most frozen, overfunded DB plans consider their timelines finite, possibly with a hibernation strategy in place or viewing a plan termination as inevitable, with limited potential use of pension surplus. IBM openly challenged this notion by directly utilizing its pension surplus to reduce ongoing costs.

According to their 2022 annual report, IBM held about $3.5 billion in pension surplus for its US DB plan and paid about $550 million to its 401(k) plan. DB plan funding requirements depend directly on the funded status of the plan, whereas 401(k) contributions are paid annually on a pay-as-you-go basis. With no funding requirement in sight for its DB plan (due to its stellar funded position), IBM could potentially eliminate the need to pay out any significant amount in cash to its 401(k) plan for years to come, instead allowing the DB plan to absorb that cost and many of its associated expenses.

What risks does IBM face?

IBM's U.S. pension plan will now likely introduce tens of thousands of new participants, with the associated costs of actuarial valuations, PBGC premiums, and annual notices that come with every qualified DB plan. PBGC premium costs, in particular, are worth noting since the flat rate will be $101 per participant in 2024, adding millions of dollars in new administrative costs.

While the account balance set up for these participants is just notional (until paid at termination or retirement), IBM will need to pay the promised "interest credits," which for a few years will be 6% and thereafter the 10-year Treasury yield. These do not necessarily tie directly to how the assets perform, and therefore, IBM will carry this asset/liability mismatch. The extent of this mismatch will depend on how IBM chooses to invest, but typically, cash balance liabilities are more challenging to hedge than traditional annuity DB benefits.