What is the difference between a defined-contribution plan and a defined-benefit plan?

Glen Brown

By Glen Brown

What is the difference between a Defined-Contribution Savings Plan and a Defined-Benefit Pension Plan?

A Defined-Contribution Savings Plan:

1)    A defined-contribution savings plan (401(k), 403(b), 457) was not initially created as a retirement vehicle but rather as a supplementary savings account; 2) A defined-contribution savings plan shifts all the responsibilities and all of the risk from the employer to you; thus, your benefit is not guaranteed for life; 3) Your benefit ceases when your account is exhausted; 4) There are no survivor or disability benefits and guarantees; 5) Your benefit is based upon individual investment earnings; 6) You assume all funding, investment fees, and inflationary and longevity risks; 7) A defined-contribution savings plan does not have the pooled investments, professional asset managers, and shared administrative costs that a defined-benefit pension plan provides; 8) Though you bear no portability risks, accounts are not always rolled over when you change jobs; 9) Changeover costs to this plan could be significant; 10) Your employer (state) will have to bear the administrative costs of both defined-benefit pension and defined-contribution savings plans when you switch over; 11) “Payments to amortize unfunded liabilities for the defined-benefit pension plan may be accelerated” (National Institute on Retirement Security (NIRS); 12) The Governmental Accounting Standards Board “requires [an] acceleration of unfunded liability payments when the defined-benefit pension plan is closed to be recognized on financial statements” (NIRS); 13) “No unfunded obligations [liabilities] for existing members are reduced when new members go into a defined-contribution savings plan” (NIRS); 14) “The loss of new members makes it difficult to finance the unfunded obligations of the defined-benefit pension plan” (NIRS); 15) The State of Illinois will not save money. Most of the State’s obligation to TRS is for contributions not paid during the past several decades; therefore, the deferred cost of underfunding cannot be eliminated by switching to a defined-contribution savings plan; 16) Shifting to a defined-contribution savings plan can raise annual costs by making it more difficult for Illinois to pay down existing liabilities. The plan will include fewer employees and fewer contributions going forward; 17) Even with a defined-contribution savings plan option, states and localities are still left to deal with past underfunding; 18) There is a several trillion dollar deficit between what 401(k) account holders should have and what they actually have.

A Defined-Benefit Pension Plan:

1)    You cannot outlive your benefit; 2) Your defined-benefit pension plan is more cost efficient than the defined-contribution savings plan; 3) Your defined-benefit pension plan offers predictable, guaranteed monthly benefits for life; 4) Funds are invested by professional asset managers in a diversified portfolio that follows long-term investment strategies; 5) The large-pooled assets reduce asset management and miscellaneous fees; 6) Your defined-benefit pension plan provides spousal (survivor) financial benefits; 7) Your defined-benefit pension plan provides disability benefits; 8) The state is responsible for funding, investment, inflationary and longevity risks; 9) Because you are not affected by Market volatility, your defined-benefit pension plan is a more effective protection than the defined-contribution savings plan; 10) Because teachers understand the value of such a plan, they are willing to give up higher wages; 11) A defined-benefit plan encourages a long-term career and stable workforce; 12) Your defined-benefit pension plan provides you with self-sufficiency in retirement; it is associated with far fewer households that experience food privation, shelter adversity and health-care hardship; 13) Your defined-benefit pension plan is less expensive for taxpayers than Social Security – a reason why legislators, et al. had negotiated for Illinois teachers to not pay into Social Security; 14) The Teachers Retirement System of Illinois is the 39th largest in the U.S. with 366,000 members (2012) (TRS); 15) The average investment returns for TRS: 9.6% (1982-2012) (TRS); 16) Your defined-benefit pension plan has an economic impact of over $4 billion on Illinois; the effect on Gross Domestic Product is $2.38 billion; jobs that are created: 30,448 (Teachers Retirement System of Illinois, TRS); 17) Defined-benefit pension plans contribute over $100 billion to annual local, state, and federal revenue in the U.S. and provide capital to financial markets (NIRS).

Sources: the National Institute on Retirement Security (NIRS), Center for Retirement Research at Boston College, National Conference on Public Employee Retirement Systems, Center on Budget and Policy Priorities, and the Teachers Retirement System of Illinois (TRS).

Glen Brown blogs regularly at Teacher/Poet/Musician Glen Brown

8 thoughts on “What is the difference between a defined-contribution plan and a defined-benefit plan?

  1. Great idea to point out the differences between defined benefit and defined contribution plans. I have talked to quite a few people who don’t know the difference between the two concepts. There are many reasons why the “reformers” want to switch us from one to the other. None of their reasons will actually benefit the individual member.

    On another point, the We Are One coalition continually stresses the following: “Passing an illegal pension bill further endangers Illinois’ finances and the solvency of its retirement systems. It simply kicks the can down the road and will save the state nothing.”

    I understand and agree with the notion that we have a revenue problem and not a benefits problem, but it is hard to explain to others how passing the rumored proposal “will save the state nothing.” It seems “obvious” to most that if benefits are reduced, then the state will be spending less, thereby “saving” money. I need a clear and understandable way to explain the fallacy of that logic. Can you help?

    1. Actually a 401k is not a bad idea on its basis. It has not had a 30 year run yet. It is just too bad most people are not disciplined or intelligent investors. At least it would keep legislators or corporate elitists from being able to steal our contracted benefits.

      1. It is a terrible idea, as Glen demonstrates. Disciplined and intelligent investors lost 30% of their portfolios in 2008, or don’t you remember?

      2. On paper I agree, Fred. That is why you stay in the game. It always come back at which point you rebalance. Obviously a near retiree shouldn’t have a majority of their money in stock funds. I’m just sayin as an alternative to being at the mercy of these thieving bastards people could have another option.

  2. The Tribune editorial from today touts a voluntary 401k type (defined contribution) plan as a plus for state workers since it “would give public workers an opportunity to direct their own retirement accounts.”

    That’s a plus??! Probably not, unless you also happen to be an investment professional.

    The Tribune editorial later goes on to proclaim that “we cannot invest our way out of” the pension dilemma.

    Contradictory?

  3. In SURS, back in the early 90s we were given the “one time” option of staying in the defined benefit program, or moving to a “self-managed” program. The overwhelming majority stayed with the defined benefit program. I do know one person, a community college teacher, who went with the self-managed program. Apparently, at least according to him, the state could not skip contributions to those programs, as the money had to actually be there to start working for him, as opposed to the defined-benefit program where the money was only there on paper (the state figured they could worry about it when it was actually time to pay benefits). I don’t know much about that program, but it does exist as a defined contribution program within the current framework. It would be interesting to know how people in those plans have done vs. those in the defined benefit program.

    Keep in mind, too, that a person can take advantage of 403b programs and put their own pre-tax money into funds in addition to their state retirement money (403b is the public sector equivalent of 401k). It makes a good safety net.

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