Employee B its

Defined Contribution

Retirement Plans
Become More
Prevalent

BY ANN C. FOSTER

Many factors have contributed to the trend in recent years
towards retirement coverage under defined contribution
plans and away from defined benefit pension plans.’ Rea-
sons often cited include changes in pension and tax laws
and accounting procedures, in addition to employer attempts
to curtail escalating pension costs. Another factor underly-
ing the recent participation growth in defined contribution
plans has been the rise of 401(k) arrangements, which give
employees the opportunity to defer income and taxes by
making contributions to their retirement plans.?

Data from the Employee Benefits Survey show that in
1985, 41 percent of full-time workers in medium and large
private establishments participated in defined contribution
Tetirement plans compared to 80 percent in defined benefit
plans.’ (See chart 1.) By 1993, 49 percent of full-time work-
ers participated in defined contribution plans compared to

Chart 1. Percent of full-time employees participating in
defined benefit and 401 (k) defined contribution plans,
medium and large private establishments, 1985 and 1993

100

80

60

40

1985, 1993

Defined

1(k) defined
benefit ion

contributor

‘Ann C, Foster is an economist in the Division of Compensation Data
Analysis and Planning, Bureau of Labor Statistics. Telephone (202) 606-
6284,

56 percent in defined benefit plans.’ Starting in the mid-
eighties, employers increasingly added 401(k) tax-deferred
provisions to their defined contribution plans or established
new plans with 401(k) provisions. Between 1985 and 1993,
the percent of full-time workers enrolled in plans with 401(k)
provisions jumped from 26 to 43 percent.5

Types of defined contribution plans

There are several types of defined contribution plans:
Savings and thrift, deferred profit-sharing, money purchase
pension, employee stock ownership, and stock bonus plans.

Savings and thrift plans. In 1993, 29 percent of full-time
employees participated in a savings and thrift plan, mak-
ing it the most prevalent type of defined contribution plan.6
(See table 1.) Nearly all participants (99 percent) were in
401(k) plans.

Savings and thrift plans require a basic employee con-
tribution that invokes an employer’s matching contribution.
Acommon matching provision is for an employer to match
half of an employee’s contribution, up to the first 6 percent
of earnings. The vast majority of plans also permit a vol-
untary contribution, which is a contribution by the employee
in excess of the maximum amount matched by the employer.
In some plans, an employer may provide additional discre-
tionary contributions based on profitability. Twelve percent
of savings and thrift plan participants were in such plans in
1993.

Most savings and thrift plans offer more than one in-
vestment choice. These include bond funds, company stock,
common stock funds, government securities, guaranteed
investment contracts issued by insurance companies, and
money market funds. Participants can usually direct their
contributions, but may not always be able to choose how
the employer contributions will be allocated. Eighty-six
percent of plan participants could decide where their con-

Compensation and Working Conditions, June 1996 42



tributions were invested. Fewer (58 percent) could decide
where employer contributions were invested. In 1993, the
number of investment choices ranged from two to seven or
more, with four being the most common.

Prior to payout at retirement or because of disability or
termination of employment, many savings and thrift plans
allowed participants to withdraw some or all of their
employer’s contributions. In 1993, 29 percent of plan par-
ticipants were able to withdraw their employer's contribu-
tions for any reason, while another 18 percent could make
withdrawals for hardship reasons, such as medical or edu-
cational expenses. As an alternative to withdrawals, em-
ployees may be able to borrow from their plans. In 1993,
48 percent of savings and thrift plan participants were al-
lowed to borrow from their account.”

Deferred profit-sharing plans. In 1993, 13 percent of full-
time workers participated in deferred profit-sharing plans.
Of those, 40 percent were in plans that use a specified for-
mula, such as a fixed percent of profits, while 60 percent
were in plans in which contributions were made at the
employer’s discretion. Only 23 percent of participants were
in plans requiring employee contributions, while 13 per-
cent were in plans allowing, but not requiring, employee
contributions. Twenty-eight percent of plan participants
were in plans with salary reduction 401(k) features, while
another 6 percent had a choice to receive a portion of the
profits in cash, with the remainder being placed in a tax-
deferred account.

Employer contributions were allocated to participants’
accounts in several ways, the most common of which is
proportional to earnings (52 percent of participants), Other

Table 1. Participation in retirement income benefits progra:
by full-time employees in medium and large private estabiistr
ments, 1983

(in percent)
Blue-
collar
Clerical and
service
78 78
i) 56
ay 40
cr 2
16 12
7 6
4
‘includes defined benefit pension plans and defined contribution
retirement plans. The total is less than the sum of the individual items
because many employees participated in more than one
Plans with employer contributions, including 401(k) and non-
401k) plans.

Employee stock ownership and stock bonus plans.

43 Compensation and Working Conditions June 1996

common allocation methods were those proportional to
employee contributions (19 percent) and those based on
earnings and service (11 percent).

Features commonly found in savings and thrift plans
common allocation methods were those proportional to em-
ployee contributions (19 percent) and those based on were
not as readily available to participants in deferred profit-
sharing plans. For example, about half of participants were
enrolled in plans that allowed them to choose investments.
Only 21 percent were in plans allowing the withdrawal of
employer’s contributions and only 23 percent were in plans
with loan provisions.”

Other types of plans. Eight percent of full-time workers
participated in money purchase pension plans in 1993.
These plans are funded by employer contributions, most
often a percentage of an employee's earnings. Employee
contributions are rarely required or allowed. When per-
mitted, however, employee contributions are usually made
on a pretax basis. Accounts may not be accessed, by either
withdrawal or loan, prior to retirement. These plans are
sometimes thought of as pension plans because they often
provide a fixed payment to participants at retirement. This
is accomplished by using the funds accumulated in an
employee's account to purchase an annuity that guarantees
a periodic payment for life.

Only 3 percent of full-time employees participated in
stock plans in 1993. Of them, less than 0.5 percent partici-
pated in stock bonus plans, while nearly 3 percent partici-
pated in employee stock ownership plans (ESOP’s). A stock
bonus plan specifies employer only or employer and em-
ployee contributions to a trust fund that invests in various
securities. ESOP's are usually financed entirely by the
employer and must be designed to primarily invest in com-
pany stock, They also may be the means by which employ-
ees purchase their company, with stock periodically dis-
tributed to employee accounts as loans used to finance the
purchase are repaid.

Cash or deferred arrangements

All defined contribution plans, except ESOP’s, may come
with cash or deferred arrangements, commonly called 401(k)
plans. These arrangements allow participants to choose
between receiving currently taxable income or to defer taxa-
tion by placing pretax income in a retirement account. If an
employee participates in a 401(k) plan, income taxes on
the employee’s contributions and earnings are deferred un-
til the employee begins plan withdrawal. The employee's
contributions are sometimes referred to as employee elec-
tive deferrals.

Most employees (84 percent) under 401 (k) arrangements
are in plans with employee contributions rather than free-
standing plans without them. Almost all employees in
401(k) plans with an employer match, were in salary re-
duction plans. For 79 percent of them, a savings and thrift
plan was the vehicle for salary reduction and for 10 percent


Chart 2. Percent of full-time employees participating In
cash or deferred arrangements, defined contribution
with employer contributions, medium and large private
establishments, 1993

Seat Sergey
= plans 10% plans

and stock salary
reduction plans.
Doterralot 8%
profit sharing
2%

it was a deferred profit-sharing plan. Another 8 percent
had other vehicles such as a money purchase pension plan
or stock plan. (See chart 2.)

An alternative available to some profit-sharing plan par-
ticipants is a deferral of profit-sharing allocation. This gives
participants the choice of receiving the allocation immedi-
ately or deferring it and postponing taxation until distribu-
tion. Two percent of employees in defined contribution plans
with an employer contribution participated in such plans.

The data in this report are from the Bureau of Labor
Statistics’ Employee Benefits Survey of medium and large
private industry establishments. The survey covers estab-
lishments with 100 or more workers. Only data for full-
time workers are presented.

For more information on 401(k) and other defined con-
tribution plans, contact Ann C. Foster at (202) 606-6284;
Fax (202) 606-7856.

—ENDNOTES—

"In defined contribution plans, an account is established for each partici-
pating employee. Generally the employer, and often the employee as well,
make fixed (or defined) contributions to the account. Benefits at retirement
are not predetermined, but depend on contributed amounts and any invest-
‘ment camings. In defined benefit formulas are used to
calculate retirement benefits, which are usually based on salary and number
of years of service.

2 should be noted that a small part of the decline in defined benefit plan

stems from the 1988 Employee Benefit Survey expansion to in-
clude all service industries. Defined benefit pension coverage has tradition-
ally been more prevalent in goods-producing than in service-producing in-
dustries. For more information, see Benefits in Medium and Large
Firms, 1988, Bulletin 2336, Bureau of Labor Statistics, 1989.

‘The term 401 (k) refers to the section of the Internal Revenue Code that
allows employees to choose to have a portion of their compensation (other-
wise payable in cash) invested in a qualified defined contribution plan on a
tax-deferred basis. In the Employee Benefits Surveys, similar arrangements
authorized under section 403(b) of the Internal Revenue Code are also tabu-
Jated as 401(k) plans.

3 Some workers have coverage under both a defined contribution and
defined benefit plan, thus, the total may exceed 100 percent. For additional
information see Employee Benefits in Medium and Large Firms, 1985, Bul-
Jetin 2262, Bureau of Labor Statistics, 1986.

* Data for 1993 used in this article were obtained from Employee Ben-

efits in Medium and Large Private Establishments, 1993, Bulletin 2456,
Bureau of Labor Statistics, 1994.

> Nearly all of these employees participated in defined contribution plans.
Defined benefit provision plans with such features are rare in the private sec-
tor.

The Employee Benefits Survey only collects detailed information on
defined contribution plans (with or without 401 (k) features) with an employer
contribution. For this reason, employees participating in freestanding plans
are not included in table 1.

For more information on savings and thrift plans, see Ann C. Foster,
“Employee Participation in Savings and Thrift Plans, 1993,” Monthly Labor
Review, March 1996, pp. 17-22.

*For more information on profit-sharing plans, see Edward M. Coates,
IH, “Profit Sharing Today: Plans and Provisions,” Monthly Labor Review,
April 1991, pp. 19-25.

* For 401 (k) plans with no employer contributions, the Employee Ben-
efits Survey participants as those making contributions. For plans offering
cash of deferred arrangements, whether of not workers actually made pretax
contributions.

1° For information on small private establishments, see Employee Ben-
efits in Small Private Establishments, 1994, Bulletin 2475, Bureau of Labor
Statistics, 1996. For more information on benefits provided to state and local
government workers, see Employee Benefits in State and Local Govern-
ments, 1994, Bulletin 2477, Bureau of Labor Statisites, 1996.

Compensation and Working Conditions June 1996 44