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Special Report July 2, 2009, 5:00PM EST

IBM Reinvents the 401(k)

Staffers were nervous when Big Blue replaced its pension plan with a souped-up 401(k). Now, the plan could be the new gold standard

By Amy Feldman

Back in January 2008, IBM (IBM) replaced the last of its pensions with a new-and-improved 401(k). The plan came with plenty of enticements, befitting a company that earned more than $10 billion on $99 billion in revenue the previous year. There were generous matching contributions, super-low fees, custom-designed portfolios, free access to financial coaches, and more. Even so, critics hammered IBM's move as one more sign of retreat from the secure retirement benefits of the past.

Today, hardly anyone is complaining about IBM's 401(k), least of all the participants. The plan is sumptuous compared with offerings from most companies. Across the U.S., 401(k)s have been bludgeoned by the financial crisis. Balances have shrunk to a fraction of their former value, and many companies have slashed matching contributions. Yet IBM is sticking with its plan—one of the largest in the U.S., with $27 billion in assets. "In my job, I often hear horror stories," says J. Randall MacDonald, senior vice-president for human resources, who led the shift from pension to 401(k). "I don't hear horror stories about the 401(k)."

IBM's creation isn't revolutionary in design or implementation. But it combines most of the best features of 401(k) plans at other companies, then leverages IBM's size to wrangle cut-rate fees from investment firms that want to manage its retirement assets. With 94% participation among more than 100,000 active U.S. employees, the plan boasts an average employee balance of $127,000, more than double the national average. Fees, which have a bigger impact on long-term results than most people realize, typically are just 10 basis points, or 0.10%. "IBM takes a very paternalistic and serious attitude in terms of the quality and the cost to participants," says Ted Benna, chief operating officer of pension consultant Malvern Benefits and the man considered to be the father of the 401(k).

Having weathered the recession, at least so far, IBM is now toying with some truly radical ideas. MacDonald hopes someday to meld retirement and health benefits into compensation, leading to a performance-based 401(k) through which top performers could be rewarded with better benefits. Given IBM's size and clout, any trail it blazes in this area could alter the retirement landscape dramatically.

AN EARLIER FUMBLE

The path to IBM's 401(k) epiphany was marred by at least one big blunder. In 1999, IBM redesigned its pension and put in place a hybrid called a cash-balance plan. Legally, this is a defined-benefit plan, but it has more in common with a 401(k). The company contributes money, and employees receive the funds as a "cash balance" in their accounts rather than as lifetime income in retirement.

There was nothing paternalistic about this shift, which was all about costs. Employees fumed over lost benefits, and a class action followed, claiming the change discriminated against older workers. The dispute went all the way to the U.S. Supreme Court, which, in 2007, declined to hear the case and left standing an appeals court ruling in IBM's favor. But by then the case had become one of the biggest human-resources debacles in Big Blue's history.

Against this backdrop, in 2005 CEO Samuel J. Palmisano assembled a team of six top executives, including MacDonald and Karen Salinaro, who was then vice-president for compensation and benefits, to rethink retirement goals and priorities. The team spent two years debating what the new 401(k) would look like—something with more features and benefits than a regular 401(k) but less expensive than the old pension. "They wanted to make a statement," notes Alicia H. Munnell, director of the Center for Retirement Research (CRR) at Boston College.

For IBM, there was no question the pension had to go. Among workers with retirement plans, the percentage covered by pensions fell from 83% to 30% from 1980 to 2006, according to CRR. Meanwhile, those in 401(k) plans, originally meant to be supplementary only, rose from 40% to 92%.

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