Who's in charge of your pension?

Yesterday during my research for retirement benefits I ended up at several union websites. All unions push the same type of retirement system, defined benefit (DB). This is the type of pension the military provides to their retirees. A defined benefit based system usually has some formula utilized to calculate a specific monetary benefit to the retiree for as long as they live. There is also an option associated with DB to ensure a retiree's survivors can partake of the retirement plan. The designated survivor will get a reduced award amount for as long as the survivor lives. This obviously will come at a price to the retiree as they will pay a premium for this "insurance." The military option is called the Survivor Benefit Plan (SBP).

The other retirement system is called defined contribution (DC). This system is based on the contributions to the system vice the benefit of the system. An IRA or 401(k) plan is a DC system. One of the drawbacks to this system is that the account can reach zero before the retiree has passed on. Running out of money is a just concern.

So which retirement system is pushed by the unions? If you guessed DB, you are correct. In the DB system, the employer is responsible for the system; in the DC system, the employee is responsible for the system. Unions are anti-employer, so, of course, they would be for a system that puts all the burden on the employer. I think unions believe people cannot be trusted to run their own retirement fund; therefore, it should be left to someone else. (There's a covert message in that last sentence!)

Some argue that a retiree should have a three-legged stool approach (Almedia and Fornia, 2008). This approach is one of relying on social security while having both types of plans. A way to look at having all three types is one of diversification, or not having all eggs in one basket.

There are advantages and disadvantages to both plans. In the DB system a huge advantage is only the employer pays into the system (unless it is a public service sector job, then the taxpayer pays a portion while the employee pays another portion). For the most part, union pensions require only the employer to pay into the system. This creates a large pool of money that can be managed by one manager for optimum growth (another advantage). Again, I reiterate, only the employer pays into the system. So a company that pays into a DB system in order to keep the same profit rate will recoup that money a different way: raise the cost of their goods or service. This fact is a disadvantage to the consumer or user of the company.

In the DB system, the benefit is the same for how long the retiree lives. When looking at a DC system, remember, it can run out of money. This is a disadvantage to the DC system. However, a retiree can utilize the DC to purchase an annuity which would then pay a specific amount to the retiree for their life span. In the same report by Almedia and Fornia, they say most owners of DC plans won't do that or know to do that so a DB system is better. Again, a DC owner is not smart enough to take care of themselves, so a system that takes care of them is better.

From an employer standpoint, the DB has a huge advantage over a DC. This advantage lies in the fact that because the money is in one big pot, the employee cannot take the DB with them if they want to change jobs or employers (there's no way to say whose dollar in the account is whose). This makes the employee loyal to the employer thus the employer won't have to find a replacement and spend the money to train them to replace the employee who wants to leave. The DC system, though, is portable. An employee can take their retirement funds with them. In a DB, the funds belong to the employer until the employee retires. In a DC, the funds belong to the employee at all times. Of course, realize that if someone works for a DB system company and is not union, at sometime close to the retirement age, the company just might decide to let that someone go. This way the DB fund will not have to pay the benefits to the employee because the employee did not meet the retirement requirements. So I hope you if work for a DB system company, you are union!

Consider the following: from yesterday my scenario had someone working for twenty years then retiring. They paid $25,200 into a DB system and received $360,000 from the same system. Assuming matching funds actually paid into the system by the taxpayer, this requires a rate of return of over 20% per year to get to that amount. I really don't see a DC matching that. Or can it? But also consider the following, what happens when the retiree dies and has not received all of the funds? Who gets it? Even after paying the survivor, there will be money left over. Who gets that money? In a DC, the funds can be transferred to a survivor. All of the remaining funds (of course, this depends on a half-way decent estate lawyer). If a union has control of the DB fund, who gets the money?

To be honest, I don't like the benefits of the military system under which I retired. If the government doesn't have the money to pay me, how will they pay me? Look at what's happening in Greece. I am dependent on the government. I want to be dependent on me. I've already decided that when I get my second career started, I am going to look for a company or firm that offers a 401(k) or similar plan. This way I'm in control of my money. I'm the one who wants to retire, why should I not be responsible for my own retirement? Someone I met a few months ago, left their job to start their own business because they realized that all the money being brought into the business they worked for was going to the retirees and overhead, leaving not a lot of funds for the company. He left so he could provide for himself now and into the future.

So, who's in charge of your pension?

Mike

P.S. I hope you check out some of the following references:

References:

Credit federal. (2006). Retirement pensions. Financial News. Retrieved 25 May 2010 from http://creditfederal.com/article/articles/126/1/Retirement-Pensions

AFL-CIO. (n.d.). Defined-benefit pensions. Retrieved 25 May 2010 from http://www.aflcio.org/issues/retirementsecurity/definedbenefitpensions/

National association of state retirement administrators. (n.d.) Defined benefit/defined contribution issues. Retrieved 25 May 2010 from http://www.nasra.org/resources/dbdcissues.htm

Dinkytown.net. (n.d.) Investment rate calculator. Retrieved 26 May 2010 from http://www.dinkytown.net/java/InvestmentReturn.html

Almedia, B and William Fornia. (2008). A better bang for the buck: The economic efficiencies of defined benefit pension plans. National institute on retirement security. Retrieved 25 May 2010 from http://www.nirsonline.org/storage/nirs/documents/Bang%20for%20the%20Buck%20Report.pdf

National association of state retirement administrators. (2005). Myths and misperceptions of defined benefit and defined contribution plans. Retrieved 25 May 2010 from http://www.nasra.org/resources/myths%20and%20misperceptions.pdf

Sonnanstine, A and Brian Murphy and Paul Zorn. (2003). List of advantages and disadvantages for DB and DC plans. Retrieved 25 May 2010 from http://www.nasra.org/resources/GRS%20DB%20DC.pdf

CalPers benefit booklet. (2008). Retrieved 25 May 2010 from https://www.calpers.ca.gov/mss-publication/pdf/xxBu0jYBuPcir_pub-2-Aug2008.pdf