5 types of hybrid retirement plans for state and local employees

A new resource by NIRS identifies the characteristics and drawbacks of different types of hybrid plan designs for public employees that combine elements of DB and DC plans.

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Hybrid retirement plans for public employees have been around for decades, but they have experienced an increase in momentum in recent years as jurisdictions have sought to reduce costs. In its recently published resource, “Hybrid Handbook | Not All Hybrids Are Created Equal,” the National Institute on Retirement Security (NIRS) provides an overview of public sector hybrid retirement plan design and recommendations for plan sponsors considering adding a hybrid option. NIRS said some shifts to hybrid designs have been made without a proper evaluation of the long-term implications of the plan changes, while others are well thought out and more likely to provide retirement security to employees, which aids with recruitment and retention of employees.

Hybrid plans are heterogenous and differ in terms of implications for workforce management, retirement security and cost objectives, said NIRS. The institute outlined five major types of hybrid plans and key considerations of each.

1. Cash balance plans

Cash balance plans are the oldest type of public pension hybrid plan, dating back to 1947 when the Texas Municipal Retirement System was established. These plans blend features of both Defined Benefit (DB) and Defined Contribution (DC) plans, with annual accruals to notional individual accounts for each member within the plan. These annual accruals, which are typically a percentage of salary paid by both employees and employers, are credited with interest so the employee account grows over a career with both additional accruals and interest. At retirement, employees either receive a lump sum payment or convert the balance to an annuity.

The accrual pattern in cash balance plans is more similar to that of DC plans, which favors younger employees in terms of growing retirement income, said NIRS. Even with strong annuitization policies, mid-career and older hires may be provided less retirement income than they would receive with traditional DB plans. The retirement security provided via a cash balance plan strongly depends on decisions made when the plan is established about interest crediting and annuitization.

2. Vertical hybrids

Vertical hybrid plans combine both a DB and a DC plan. In vertical hybrid plan design, the DB plan is applicable for salaries up to a set level, or integration point, with the DC plan taking over at salaries above that point. The integration point can vary widely and can be fixed or indexed. Vertical hybrid plans are rare, and perhaps the only U.S. example of a vertical hybrid is the City of Philadelphia’s Plan 16 for employees hired after Aug. 20, 2016, said NIRS.

A potential concern for vertical hybrids is that members will typically have a greater participation in the DC plan later in their career when they are less able to withstand risks in their allocations and have less time to grow their account balance through compound interest.

3. Horizontal hybrids

In horizontal hybrids, both DB and DC plans apply to the same salary amounts in parallel but the level of benefits offered by each of the plans is typically lower than in a standalone plan. When the magnitude of DB benefits is reduced, the plan sponsor absorbs less risk, particularly investment and mortality risk, as members bear more of those risks in the DC portion of the plan, said NIRS. A key benefit of horizontal hybrids is greater portability and perception of the value of benefits by members who terminate prior to retirement age.

While there’s only one example of a vertical hybrid, horizontal hybrids are the most prevalent of hybrids in use in the public sector, said NIRS.

4. Choice schemes

The fourth type of hybrid allows participants to choose between a DB and a DC plan. The impact on retirement security of choice schemes is largely tied to the member making the right choices for their individual situation. However, NIRS said there is evidence that members are not making optimal plan decisions. Clear employer communication along with the opportunity to re-evaluate after working past the first year can help employees make better plan decisions, NIRS said.

5. Risk-sharing defined benefit plans

Risk-sharing plans vary widely. Generally they are DB plans in terms of pooling membership and providing lifetime benefits but add features resulting in risks being shared between the sponsor and member that traditionally are borne by the sponsor. These risk-sharing provisions are usually in the areas of contributions, cost-of-living adjustments in retirement and benefit accrual while working.

Kristen Beckman is a freelance writer based in Colorado. She previously was a writer and editor for ALM’s Retirement Advisor magazine and LifeHealthPro online channel. She also was a reporter for Business Insurance magazine covering workers compensation topics.

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