The Variable Benefit Pension Plan Model

January 31, 2019

Some pension plan trustees have begun implementing a variable benefit pension plan design. Essentially, a variable benefit pension plan or a variable annuity pension plan is a type of plan in which the payout of benefits changes depending on how well the plan’s investments have performed. The plan defines an assumed investment return rate, often between 4% and 6%, known as the hurdle rate. If the investments outperform the hurdle rate, benefits earned to date are increased proportionally; if the investments underperform the hurdle rate, benefits are likewise decreased proportionally. This means that retirees may see annual benefit increases or decreases based on the market.

 

This type of plan can be viewed as a compromise between a traditional defined benefit plan and a defined contribution plan. While this type of plan design certainly shifts more risk to the participant than a defined benefit plan, plans can build in safety features to shield participants from too much risk. For example, plans can implement a floor on how low benefits can dip if the market is performing especially poorly or create a ceiling for benefits to build up reserves for when the market is performing well.

 

While some participants may be unhappy to shoulder more of the volatility of the market, this type of design may save future participants from an underfunded or insolvent plan years down the line.

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