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

IBM Reinvents the 401(k)

(page 3 of 3)

Barclays Global Investors, Neuberger Berman, Pimco, State Street (STT), and Vanguard Group—all are top-notch asset managers in IBM's lineup of core investments. "We try to negotiate as well as we can to wring every penny out of costs," says Ray Kanner, chief investment officer of IBM's retirement funds.

The plan also nudges participants toward better choices than they may have made on their own. Behavioral finance research by academics Richard H. Thaler of the University of Chicago Booth School of Business and Shlomo Benartzi of UCLA Anderson School of Management demonstrated the merits of putting the 401(k) on automatic pilot. One feature, auto-enrollment, pulls workers into retirement plans unless they opt out. Another, auto-escalation, increases contributions along with raises in pay—again, unless they opt out. In studies, these tricks substantially increase 401(k) participation and savings. IBM also offers automatic rebalancing, meaning employees' portfolios are automatically reset to the asset allocation they want over time.

A PERFORMANCE LINK?

Custom target-date funds are another feature IBM uses to serve employees who don't like to manage their own money. Target-date funds are portfolios that set asset allocation based on how close a participant is to retirement; the funds then ratchet down risk (by decreasing equity exposure, for example) as the retirement date draws nearer. Such funds got a lot of flak after some off-the-shelf products with target dates of 2010 plummeted in the market downturn. IBM, like some other companies with billion-dollar 401(k) plans, has created its own customized target-date funds. Those funds mix indexed portfolios, which are at the core of IBM's plan offerings, and active portfolios. To hedge against inflation, plan managers threw in Treasury Inflation-Protected Securities and alternative assets such as commodities and real estate.

IBM aims to push the envelope further. "Suppose you made a 401(k) plan that was performance-based?" MacDonald asks. "If everybody gets paid on performance, shouldn't there be benefits based on performance? That's what it means to be a performance-based culture."

MacDonald won't go into details about what such a plan might look like and stresses that the concept remains futuristic. It could mean that IBM would take all of its benefits, whether retirement or health, and turn them into defined-contribution plans, so they look more like compensation. Once those benefits could be compared, married and single employees could be treated the same, as could workers with different financial issues. Employees would get more of what they needed—if you didn't need dependent health care, perhaps you could get extra retirement benefits—and top-performing employees could be rewarded with additional benefits.

Although a performance-based 401(k) would be new, it wouldn't be entirely novel. Profit-sharing plans have always had some element of reward for performance, and extra benefits received by highly compensated employees, such as stock options or deferred-compensation plans, are designed to differentiate among workers. Pam Hess, director of retirement research at consultants Hewitt Associates (HEW), notes that some companies have different match structures based on employee tenure. In those cases, employees might get a match up to 6% of pay—or 7% or 8%, depending how long they had been with the firm. "It gets to the question of the whole company and its benefits," Hess says. "How do you spend wisely?"

A thicket of legal, tax, and design complications would need to be sorted through before any such plan could come into being. To maintain a level of financial security for all and not run afoul of anti-discrimination rules required of 401(k)s, there would need to be a floor on benefits for employees—and the extra benefits would need to be spread across top performers, not just handed out to the highly compensated. That might mean comparing workers at similar levels, retirement consultants say, perhaps within salary bands.

IBM is painstaking about due diligence, so whatever design it comes up with is bound to be tested extensively. MacDonald says he knows of no other company that has tried what he envisions for IBM. "That's why I like it," he says. "It's only a matter of figuring out when, why, and how."

To return to the Retirement table of contents.

Feldman is an associate editor with BusinessWeek in New York.

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