Can we discuss the relative advantages/disadvantages of defined benefit vs. defined contribution plans?
As I see it there are just too many problems with defined benefit plans to ever make them worth the risk. Right now we have big financial problems at Ford and GM, at least partially because of the obligations they’ve taken on with their defined benefit pensions and health care plans. I think I read that when you buy a new GM car $1500 of the cost is for retiree medical care. There are also big problems with the airlines. And the city of San Diego. And NY state. And Social Security.
The problem IMHO is with the basic format. You can pay employees for labor this year with promises of income and health care thirty or forty years from now. Now even if the directors of the company are the most decent people you could find they could still wind up in the same situation as GM or United Airlines. A new company opens for business with young employees, no retirement costs for a long time and you have to compete with them on price. Good luck.
With local and federal governments it’s probably worse. It’s very easy to buy the votes of municipal employees by making promises for deep in the future.
And with the life expectancy getting longer and longer there’s no reasonable way to calculate how much money should ever be set aside. Not that corporations or governments are capable of setting aside money for people anyway.
The defined benefit plans seem much safer. The employee contributes. The employer contributes. The employee then has his own personal “lockbox,” to borrow Al Gore’s phrase. He does not have to worry about who’s running the company. He doesn’t have to worry about what Congress will decide to give him as his SS payment.
I’d like to hear the opposite point of view. Why would anyone, especially liberals, want to take so much power from the little guy and give it to the big guy?
It all depends on which side you are on. If you are the employee, you obviously want the defined benefit plan and the employer wants the defined contribution plan. The danger of the benefit plan to the company is that there are so many variables: number of years worked, the employee’s highest salary, how long the employee lives after retirement, and how the investments in the pension fund perform. With the benefit plan the employer could end up paying for a lot more than they bargained for, but with contribution at least they know how much they will have to pay out.
Of course, pool, if you’re the employee, and GM goes bankrupt 10 years before you retire, your defined benefits could be $0. You are trusting them to be financially responsible when you reach retirement age, that may not happen. There is also the possibility of the company changing the rules sometime in the next 20 years, so your benefit changes.
The defined contribution method can be considered less risky because the money is actually there, in an account with your name on it, in safe investments (you hope).
Actually, if the company goes under, you’ve got the Pension Benefit Guaranty Corporation to pick up most of the slack. Your benefit may be reduced, but you’ve still got insurance. Which isn’t the case if your company decides to Enronize its portfolio.
In addition, at least with a unionized company, there are trustees on both the labor and the management side, each of whom has a fiduciary duty to the side he represents. The company cannot unilaterally change benefits in order to make its own burden easier.
And, if I may pontificate for a minute, the defined benefit plan is, in my mind, superior. If you’re in contract negotiations and your employer is hesitant to commit to wage increases or fully-funded healthcare premiums, the pension option allows for the employer to make minimal (or even NO) up-front contributions, because a plan that is fully funded can generate enough interest to pay full benefits even if every eligible member retired tomorrow. A well-run pension plan can generate dollars’ worth of benefits for pennies, and is fiscally advantageous in negotiations when money has to be saved NOW.
If I had to choose between betting on the financial stability of my employer with the government as its backer (defined benefit) or betting on the integrity of that emplyer with the stock market as its backer (defined contribution), I’m going with the former.
Another angle to look at is that with a defined benefit plan, you’re rewarded for staying longer at a job. Oftentimes if you leave before, say, 5 years, you get nothing. And the final benefit is calculated based on a formula involving your highest-earning years, and the total number of years you worked for that company. That was great in the days when someone typically worked for the same company all his career.
With today’s job-hopping trends, defined contributions can result in a better deal. I don’t recall what the vesting laws are these days but you may be more likely to get something after a shorter time. My company’s policy was (IIRC) a step-vesting plan so you got some of their contributions if you left in as lttle as 3 years; may be faster these days (I’ve been there long enough to be fully vested regardless so haven’t been paying attention to the details).
Defined benefit is great, IF the company is doing an adequate job of funding the pension fund. Many do not. Even the US Government’s plans are underfunded, for their civilian employees’ funds (CSRS / FERS; not talking about Social Security). I imagine we’re looking at a train wreck as more companies’ funds start having problems due to a long history of underfunding.
PBGC only replaces part of your pension, which is obviously better than nothing.
At least with defined contribution plans, you do know what you’ve got in the bank. The downside of those is, depending on the type, you may have to control the investments yourself, and if you screw up, well, it’s Alpo for dinner.
As a minor hijack: my company was sold to a larger one a few years ago. As a result, I could theoretically start taking my defined-benefit pension right now. 20 years before normal retirement. Yeah, it’d be 60 bucks a month. Well, less than that, as I’d need to take the spouse-support reduction so Papa Zappa would have 20ish bucks a month if I croaked I think I’ll hold off and take the 250 bucks (less spouse reduction) at retirement time!
It’s hard to imagine anybody willingly choosing a pension over a 401(k). Pension plans give the worker no control over their choices. The money is “promised” to them, but can be looted, lost or stolen.
With a 401(k) or IRA plan the money belongs to the worker. It cannot be stolen by anyone. It cannot be looted or mis-managed by corporate interests beyond the workers control. The fund can follow a worker from one company to the next. The money gets distributed as the worker chooses upon his or her death. The worker, not the corporation has control of investment choices. The worker can be assured that all interest and dividends generated are being compounded for his benefit.
There really is no aspect where a pension is better. The choice is very simple. Hopefully some day soon we won’t have old fashioned pensions anymore at all.
Debaser, the crux of the Enron scandal was that the employees had no control over where there 401(k) money was invested, and large portions of it were locked into Enron stock, which was driven into the toilet by the mismanagement and criminal activity of the executive officers of that company, who also (and, by dint of being Enron execs) had control over every aspect of where the employees’ money went and how much of a return it earned.
There is no way under the sun that I can conceive of anyone submitting his retirement options to the whim of the market and the dubious trust of an executive who has no fiduciary duty to the employee.
Sadly, this has happened often enough that the Dep’t o’ Labor has felt the need to put this together to help plan participants be vigilant. The most common danger in 401(k) arragements is that contributions deducted from employee paychecks, destined for the plan, are pocketed by the employer.
As far as whether I’d choose to fund my own retirement account or have my employer do it, I’d pick the DB plan every time.
As I detailed in another thread long since lost to the sands of time…
The unfortunate aspect I have witnessed is that the trend over time has been to eliminate pensions in favor of 401(k)s with no compensation to the employee for doing so. In the old days, you got your salary + company pension contributions. Then 401(k) came along and you got your salary + company matching 401(k) contributions. Now what I see is, you got your salary + …(hello? hello? is anybody there?) NO COMPANY MATCHING! To me the whole thing is a trojan-horse/slight-of-hand to “reduce the cost of labor” (steal money from the workers). They will successfully convince people that having control over “their own money” is a good thing, all the while reducing what those people are getting.
That’s not at all true, at least according to Kurt Eichenwalds latest book, Conspiracy of Fools : A True Story. In it, he goes into the controversy and makes the following points:
Enron employees were locked out of their 401(k)s for 10 days only, in November/December 2001.
In that time, the stock sank from $6.50 to $3.50.
Before that, the stock sank from $50 to $6.50. By the time the $6.50 level was reached, the 24-day period that Smith and Enshwiller detailed in their book had already passed (starting on October 16th 2001 when Enron filed the 8-K that really started the snowball effect.) So they had plenty of time before the freezing to dump their stock, and they were (well, should have been) well informed as to what was going on. It wasn’t as if wasn’t front page news or anything.
When the accounts were unfrozen, Enron employees as a whole bought more Enron stock than they sold.
Quite frankly, reading Eichenwalds account makes one wonder if people are really qualified to run their own retirement accounts.
Also, the employees overinvested in Enron in the first place, so it’s not as if they’re blameless here.
And, it was a 10-Q that they released, not an 8-K. The 8-K filing marked the end of the 24 day period mentioned above. Enron employees were locked out of their 401(k) plans after this period.
I don’t think that this is the case. Employers are always at competition with eachother for employees. The natural supply and demand of workers ensures that people make as much or as little as they are worth.
If a worker costs more due to some hidden cost other than what’s in his paycheck, then this is taken into account. An example of this is the hidden matching tax that employers pay for Social Security. This is really just a tax on the workers. Since this cost is taken into account by employers, it is ultimately being passed on to them in the form of lower wages.
Pensions would be just another example of this. As pensions become less common, workers make more money in their actual paycheck to make up for it.
Well, pensions collapse often enough that the feds had to put this together to bail all the poor souls out who have had thier pensions vanish outright.
1,061,000 people are the victims of pensions that have gone the way of the Dodo. That’s enough for me not to be interested, to say the least.
Well, that’s your choice to make. But, I can’t see why anyone would willingly choose to be in a DB plan. They are inferior in every meaningful way with other plans such as 401k’s and IRA’s.
This is outright theft, and is illegal. Taking money from someone’s 401(k) contribution or account is no different than stealing it from their paycheck or bank account.
Can you give cites of this happening on a large scale?
If a company wants to get out of paying my pension it can. They can declare bankruptcy and walk away without paying me a cent and without breaking the law. If a company wants my 401(k), then they cannot have it. There’s no way for them to get it besides somehow stealing it from me, which would be a criminal act. Nor can they have their funds that have been matched. They now belong to me, and are in an account in my name.
Which meaningful ways are you referring to? All that you’ve demonstrated is that there are companies who have defaulted on their pension obligations and that the PBGC has assumed those obligations. This says more about the companies that default than it does about the differences between DB and DC plans.
One thing I wanted to add about the Enron situation that JohnT didn’t mention. Enron made it’s entire company matching contribution in stock, and emloyees weren’t free to move that money into other investements. That’s not to dispute the other points he made though.
I think I’ll hold off and take the 250 bucks (less spouse reduction) at retirement time!