Due to rising costs and shortfalls in funding, many large employers have terminated their defined-benefit pension plans in recent years in favor of 401(k) plans and other defined-contribution plans, which shift the risks of investment performance to employees.

However, the defined-contribution universe is also undergoing significant change. According to the Deloitte Consulting 2004 Annual 401(k) Benchmarking Survey, mutual fund trading scandals and plan fiduciary issues have led many retirement plan sponsors to make significant changes to their programs.

Pension reform could be costly

In response to a widespread pension-plan funding crisis, several proposals are currently circulating in Washington to reform the U.S. pension system. Rep. John Boehner (R-OH) recently introduced the Pension Protection Act of 2005, which would attempt to fix some of the defined-benefit pension system’s funding problems that have emerged since 2001. The Bush Administration and the ERISA Industry Committee each have published their own reform proposals.

All of these proposals seek to strengthen the minimum funding standards applicable to defined-benefit pension plans by requiring any existing funding shortfalls to be eliminated more rapidly.

For hospitals and other employers that follow strict budgets in their fiscal management, these proposals could add another financial burden at a time when they can least afford it. For this reason, it seems likely that large employers will continue to terminate their defined-benefit plans in favor of defined-contribution plans.

Good news for cash-balance plans

The proposals do have some positive aspects. All will affirmatively assert that cash-balance and other nontraditional pension plan designs are nondiscriminatory by definition. This should be good news for cash-balance plan sponsors, as their plans have been in legal limbo for several years.

Cash-balance plans are useful in providing small business owners -- particularly small medical practices -- additional tax-effective savings opportunities at lower cost than defined-contribution plans alone. We expect more physician and dental practices to add cash-balance plans to their retirement savings programs as a result.

401(k) plans undergo more scrutiny

Plan sponsors are responding to the recent mutual fund and Enron scandals by increasing their reliance on investment advisors and by shifting their mix of fund offerings, according to the Deloitte survey. This has prompted the replacement of investment managers with questionable trading  practices, as well as increased monitoring of employee trading practices.

Today, a growing number of plan sponsors are instituting formal investment policy statements and formal fund-selection procedures. In addition, there has been an increase in the demand for disclosure of plan fees and fund operating expenses. These changes are a result of plan sponsors becoming more active in managing their fiduciary responsibilities in light of the scandals.

New ways to boost 401(k) participation

As for plan design, plan sponsors have been considering additional features to encourage employee participation. Interest in automatic enrollment has increased, along with a new “easy enrollment” feature in which a prepaid postcard is sent to new employees for their enrollment signature. Most plan sponsors use participation rates as the measure of employee satisfaction and, therefore, the overall plan effectiveness. A higher participation rate will also make nondiscrimination compliance easier, reducing relative administration costs.

Beginning in 2006, 401(k) plans may provide a Roth 401(k) option. Under this option, employees would make after-tax contributions (rather than pre-tax elective deferrals) with the understanding that distributions will be received tax-free. For certain participants, the Roth 401(k) may be a better option. However, there will be significant changes to administrative procedures and costs to adopt this option. Plan sponsors should evaluate the decision to offer this option carefully.

We also anticipate that additional features will be offered that will enhance plan automation for both participants and sponsors. Increased use of the Internet for inquiries and transactions, as well as real-time data access for sponsors, will enhance plan effectiveness.

Help is available

In light of all these trends and developments, many healthcare organizations are expected to make significant plan design changes over the next year. If you would like to learn how you can more actively manage your plan’s investment performance, evaluate the Roth option, or add automation features, please give your local Wipfli office a call.

Todd Peterson, FSA, is a senior manager in Wipfli’s employee benefits consulting group. He can be reached at 651.636.6468 or tpeterson@wipfli.com.