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Features of DB Plans, DC Plans, and Hybrid Plans

Introduction

The Employee Retirement Income Security Act ("ERISA") introduced extensive federal regulation of private retirement plans. The purpose of the legislation was to protect the interests of participants and their beneficiaries by mandating certain minimum vesting, funding and disclosure requirements on plan sponsors, from which governmental plans are generally exempt. However, certain federal regulations are still a fact of life for governmental plans primarily through the Internal Revenue Service ("IRS") administration of the qualification requirements of the Internal Revenue Code ("Code"). Employee pension benefit plans are divided into two general categories: defined benefit plans and defined contribution plans. In deciding which type of plan is most appropriate for a given employee, the objectives of these plans must be considered in light of the work force, the employer environment, and the employee preferences. Additionally, "hybrid plans" can also be designed where features of both defined benefit and defined contribution plans are synthesized. Before launching into the issues associated with potential hybrid combinations, however, an informed policymaker must have a working knowledge of the critical elements of "defined benefit" and "defined contribution" plans, as well as a general understanding of their respective features or characteristics.

Critical Elements

Defined Benefit Plans

A defined benefit plan is a retirement program that provides the employee with a specific benefit at retirement. This plan calculates a benefit based on a formula, often a percentage of final average pay multiplied by the years of service. Benefits are payable as an annuity for the lifetime of the member, possibly continuing for the lifetime of his or her beneficiary. The retirement plan typically funds the cost of providing these benefits through a combination of employee contributions, employer contributions and investment return.

Defined Contribution Plans

A defined contribution plan is a retirement program where members each have an individual account (or accounts) that accumulates employee contributions and/or employer contributions and investment return. At termination of employment or retirement, the retirement benefit is solely determined by the account balance. Payment options often include lump sums as well as annuities which are limited by the account balances at the time of the annuity purchase. Defined contribution plans are also known as "individual account" plans. Hybrid Plans. A number of public retirement plans have implemented hybrid plans -- plans that combine features of both defined benefit and defined contribution plans. Sometimes public policy makers create for one group of employees two separate plans, which combine to provide the features of a defined benefit and a defined contribution plan. On the other hand, some policy makers have opted for the creation of a single hybrid plan, which has the desired features of both defined benefit and defined contribution plans. Finally, some policy makers have just added to a defined benefit plan certain features of a defined contribution plan. Some of the hybrid plans are of recent vintage, but some have been in place for decades. Each type of program has its own characteristics. By comparing these characteristics to the objectives and working environment of the employees, the most appropriate type of plan can be selected. If some characteristics of each are desirable or necessary, a hybrid program can be designed. Regardless of which plan ultimately proves to be most attractive to employees and employers, it is vital that the plan is "qualified" under Section 401(a) of the Code.

Mary Beth Braitman
Terry A.M. Mumford
ICE, MILLER, DONADIO & RYAN
One American Square, Box 82001
Indianapolis, Indiana 46282-0002
(317) 236-2100