This paper takes the form of a business memo addressed to a CEO, advising on how to consolidate two different employee retirement benefit plans following a corporate merger. It explains the key differences between defined contribution plans, in which employees bear investment risk in exchange for potential market gains, and defined benefit plans, which guarantee employees a fixed monthly payout but place financial risk on the employer. The memo weighs each plan's advantages and disadvantages from both employee and management perspectives, considers the impact of recent financial market uncertainty, and concludes with a recommendation to transition all employees to a defined contribution plan while offering financial advisory support to ease the change.
Memo
To: CEO
Re: Merging Current Retirement Plans
In the wake of the recent merger, employees are understandably anxious about the decision to create a single, unified retirement benefits plan for all staff. Currently, one segment of the company operates under a defined contribution plan, while another operates under a defined benefit plan. Each arrangement carries distinct advantages and disadvantages for both employees and the company, and the decision to consolidate them warrants careful consideration of all perspectives.
In a defined contribution plan, employees contribute a portion of their salary to the plan, which the company then matches. The value of the plan can fluctuate based on market conditions. As a result, "there is no way to know how much the plan will ultimately give the employee upon retiring. The amount contributed is fixed, but the benefit is not" (Defined contribution, 2011, Investopedia).
Recent market uncertainty has led some employees to question the value of such a plan, particularly given that many people nationwide lost a substantial portion of their retirement savings during the most recent financial crisis. Nevertheless, some employees appreciate the ability to direct their own investments: "Balances accrued in [defined contribution] DC plans belong to individual employees, who direct the investments and bear the risk of fluctuating asset returns" (Retirement plans, 2009, Job employment guide). Managers, for their part, value the fact that the company's contribution is fixed and that they are not required to make up for any deficits in retirement funds. Some risk-seeking employees are also attracted to the theoretically unlimited upside of market gains, noting that stock markets have generally increased in value over the long term and that retirement investing is inherently a long-term endeavor.
The other type of retirement plan currently offered is the defined benefit plan. Defined benefit plans offer far greater stability for employees in terms of rate of return. Under these plans, an employee's payout is only "somewhat dependent on the return of the invested funds," rather than entirely dependent on market performance as is the case with a defined contribution plan (Defined benefit, 2011, Investopedia). If the investments produce an unexpectedly low return, the company must "dip into the company's earnings in the event that the returns from the investments devoted to funding the employee's retirement result in a funding shortfall" (Defined benefit, 2011, Investopedia).
For employees with limited investment experience, defined benefit plans offer the advantage of having the company manage their retirement savings entirely. The greatest benefit to employees, however, is the guarantee of a "specific monthly benefit at retirement. This monthly benefit can be an exact dollar amount, or be calculated through a formula that considers a participant's salary and years of service" (Retirement plans, 2009, Job employment guide). In short, the company bears the financial risk rather than the employee.
From the employer's perspective, defined benefit plans can serve as a powerful recruitment and retention tool. "The payouts made to retiring employees participating in defined-benefit plans are determined by more personalized factors, like length of employment," and companies can set additional parameters — such as position or performance ratings — to encourage positive employee behavior (Defined benefit, 2011, Investopedia). The structure of defined benefit plans inherently rewards long-term company loyalty, which is a particularly valuable consideration in the aftermath of a merger, when employee attrition and turnover are elevated concerns.
The recent financial crisis has influenced how both of these retirement plan types are perceived. Managers are concerned about the possibility of having to draw on scarce company revenue to cover funding shortfalls under a defined benefit structure during periods of financial downturn. Meanwhile, employees currently covered by defined benefit plans — and who have appreciated the security those plans provide — are anxious that this protection may be taken away from them, particularly given that many have built their future financial plans around the expectation of guaranteed retirement income.
These employees also argue that it is unfair to force them into a defined contribution plan, since many chose their positions at least in part because of the certainty and stability that a defined benefit plan provides. Defined benefit plans also reward employees who have spent significant time at the company — sometimes their entire working lives — as opposed to those who move on quickly. The retention value of defined benefit plans, especially following a corporate merger, should not be underestimated.
"Stakeholder anxieties and competing interests"
"Proposed transition to DC plan with advisory support"
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