Defined Benefit vs Defined Contribution Pension Plans

Chuck Hub Author 11 months ago

Clarke - thanks for visiting and commenting on this Hub.

The defined benefit type of pension will probably disappear - in fact it is already becoming rarer.

However, defined contribution plans - the 401(k) and related accounts - will probably remain. A pension is a way for a business to help retain employees and can be a work motivator if the employer's contribution is tied to profit or productivity as this gives the employee a financial stake in the organization's ongoing success. Also, so long as annual IRA contributions for most people are capped at $5,000 and savings and investment income is still subject to the income tax than 401(k) type pensions should remain popular with employees.

Thanks again

Chuck

Chuck Hub Author 2 years ago

JYOTI KOTHARI - Thank you. I am honored that you think so highly of my writing that you included it in a list of best Hubs on your blog.

I clicked on the links to your blogs from your profile page and found all three of them very interesting as are your Hubs.

Here are links to your Hub Profile and three blogs for others to check out:

Profile: http://hubpages.com/profile/JYOTI+KOTHARI

Blog 1 - Vardhaman Gems: http://www.vardhamangems-jaipur.blogspot.com/

Blog 2 - Hubbers India (which has an index of all the Hubbers from India): http://hubpages-india.blogspot.com/

Blog 3 - My Articles: http://jyoti-articles.blogspot.com/

Thanks again

Chuck

Chuck Hub Author 2 years ago

alexchia01 - I agree with you that people would be better off being left alone to manage their own retirement planning as we cannot count of employers or business for this as both of those organizations will naturally put their own interests and financial survival before that of individuals.

Thanks again for visiting and for your comments.

Chuck Hub Author 2 years ago

onewaythinky - thanks for visiting.

As to your comment, I don't know if you mean that one or both types of pension plans are not safe or something else.

Of course, pensions like any other type of investment, or anything else in life for that matter, are not 100% guaranteed. However, the defined benefit pensions of most companies are conservatively funded and there is the government's Pension Benefit Guaranty Fund which tries to insure them and rescue those that run into trouble. As to 401k plans, the individual usually has considerable control over what to invest in which should provide security for those who are very concerned about that (of course, the more secure the investments the less opportunity for growth so there is always a trade off between safety and rate of return).

Chuck Hub Author 2 years ago

jrcmail - As Benjamin Franklin reminded us "The only things certain in life are death and taxes."

Chuck Hub Author 2 years ago

The Rising Glory - thanks for your comments.

I am familiar with Robert Kiyosaki having read a couple of his books and attended one of his company's seminars. He has a lot of good ideas and I have the greatest respect and admiration for him and his ideas.

You are correct that one of the problems with defined contribution plans is that people don't take the time to learn about money and therefore may not manage their plans as well as they could. However, most defined contribution plans are not only portable in that employees can take the plan and money contributed to date with them when they leave an employer but, at that time they can also change managers if they so desire. Also, regardless of how much or how little a person knows about money, they do have control over these plans which is not the case with defined benefit plans. Finally, as to financial knowledge and management, I have seen some studies that showed people who set up automatic deposits to such plans and then basically ignore them for years often do as well or better than many who actively manage such plans.

Thanks again for your comment.

Chuck Hub Author 2 years ago

MikeNV - theoretically the U.S. government, using its power to tax and/or print money, is the only entity in the United States that can guaranty pensions. However, as a sovereign entity it can also repudiate its obligations as governments in other nations have done in the past. Further, as I have pointed out in my Hub on Social Security ( http://hubpages.com/hub/The-Social-Security-System ) the system is legally not a pension plan in which contributors have a property right and own the money they and their employers pay into the system but, rather, two separate laws - one a welfare law that provides for the Federal government to transfer income from workers to retirees and the other an income tax law that imposes a special income tax on worker's paychecks (unlike the regular income tax law the Social Security tax does not tax investment income, royalty income, etc. but only wage income). The Supreme Court has ruled on two separate occasions that workers have no right to the money they have put into the system and have reaffirmed the right of Congress to repeal either or both the the laws that make up the Social Security system at any time by a simple 51% vote.

Because of the voting power of those already retired and those nearing retirement there is little danger of Social Security being repealed any time soon. However, should the balance of voting power tip in the direction of younger workers who rebel at paying the increased taxes needed to continue to pay retirees the law could be repealed. So there is a very real political danger to this system.

The PBGC is a Federal government corporation that insures private pensions. However, in order to preserve their capital to cover as many failures as possible, they generally, upon taking over a failing and underfunded pension fund, set about reducing monthly benefits to the retirees. So, while the PBGC provides some security, it does not provide complete protection to a person's defined benefit pension.

Thanks for commenting.

Chuck Hub Author 2 years ago

justemailme - thanks for your comment and observation. However, the risk that you cite refers to unfunded plans where the funds to pay the pensions come out of the current revenues of the company or government (Social Security is an example of an unfunded plan where the Social Security payments to current retirees comes from the Social Security taxes paid by workers each payday).

For funded plans in which money is invested over time before the workers retire this risk is not present as the funds to pay the pensions to the retirees has already been set aside. In some cases funded plans are controlled and managed by the company the retirees worked for, while in other cases whenever a worker retires the company simply withdraws from the fund the amount needed to purchase an annuity (for more on annuities click here http://hubpages.com/hub/Using-Annuities-to-Guarant ) that will pay the promised monthly pension amount to the retiring worker for life. In this case no matter what happens to the company the retiree's pension came from the retiree is unaffected as his/her pension is now independent of that company and what happens to it.

Chuck Hub Author 2 years ago

Ralph, You have had quite a career and I admire your for having done so well.

I,too, will probably get to collect at least some Social Security income but because of uncertainties about the underlying finances am reluctant to include it in my current planning.

The system obviously cannot go on forever the way it is funded and, the law as written and interpreted by the Supreme Court, provides no guarantees that anyone will collect it. So my concern with the system is will the day of reckoning come in my time or not.

I am hoping to collect it and expect to get at least some of my money back but am relying on other sources of funding in my retirement planning.

In the mean time I am trying to get my four children through college without having to refinance my mortgage. Fortunately one of the fringe benefits of working at a community college is that they can attend there for their first two years tuition free so long as I am employed which only leaves the last two years which, so far, hasn't been too bad given that college costs in Arizona are not as high as in many eastern states.

Chuck

Chuck Hub Author 2 years ago

Ralph, I agree that you and I are in a good position with the pension and IRA/401(k) plans we have and that a loss or reduction of any one of them would hurt our retirement standard of living.

In my case I am still working and contributing to my retirement plans but plan to take early retirement in the near future. To prepare for retirement I have been working on developing some side ventures which I am using the income from now to pay down things like our mortgage so as to reduce future expenses.

I hope things continue to go well for you and look forward to getting together with you the next time you are in Tucson.

Chuck

Chuck Hub Author 2 years ago

Ralph - thanks for your comments and added information.

I agree with you that people changing jobs and companies changing hands adds to the problems in this area. There have been a number of articles in recent years about people spending months trying to straighten out problems with their pensions due to confusion resulting from job changes, changes in ownership of companies and changes in the companies that administer and act as trustees for company plans.

A number of retirees have suddenly found their monthly payments reduced when a new trustee confuses their plan with that of another plan from a company that was taken over by their employer (or they were in the company taken over) and not only cuts their benefit (to bring it in line with they think the person is under) but ask for the retiree to re-pay what the administrator feels they were over paid.

A few years ago my sister spent three or four months attempting to get my Mother's health insurance re-instated after the company that was handling some of the retiree health plans for the company my Father had retired from. The bank he had worked at for over 30 years had changed hands a couple of times while he was employed there and a few more times after he had retired. The current incarnation of the bank he had worked for had ended up with dozens of different plans to administer and not only outsourced different plans to different companies to administer but also, in some cases including my Mother's, used separate trustees for the health plan portion and pension payment portion of some of the plans. My sister's problem was that no one knew who handled what plan and it took her four months of telephone calls to finally find the company in charge of the health plan my Mother had and get them to contact the health insurance provider and get the health insurance re-instated.

The 401(k) and similar portable plans are better in the sense that the employee can not only take those plans with them when they leave or retire but can also roll them into another 401(k) or IRA plan upon leaving the company - this allows them to avoid the confusion of the plan getting lost in a merger as well as giving them a chance to select a new provider with lower fees and/or better choice of investments.

Unfortunately, as you state, while a person is employed with a given employer they are stuck with whatever provider and investments the employer chooses.

As to your statement that the best situation is an employer that offers a good defined benefit plan along with a 401(k) - I totally agree with you. However, defined employers with defined benefit plans are becoming fewer and fewer.

I have a defined benefit plan to which both my employer and I contribute as well as a 403(b) (the college and school version of a 401(k) plan) to which only I contribute. Up until this year my employer only offered the choice of three providers for the 403(b) plans and all were insurance companies that only offered variable annuities for investment choices - these, of course, have some of the largest fees. This year they finally offered a company with mutual fund as an option. The defined benefit plan I have is very good in terms of the benefit, but given what I have been reading about the problems I cited in my comment above with companies going bankrupt and reducing the benefits, I have decided to take early retirement when I am eligible, get another job and invest the pension income in a fixed annuity while I am still working - this way I should be able to get back my contributions and have a back up income in the event the pension payments are cut in the future.

Thanks again.

Chuck

Chuck Hub Author 2 years ago

bobmnu - thanks for your comment.

You are correct in stating that when big companies go broke and file for bankruptcy pensioners can lose. In the 1960s and 1970s many large unionized corporations brought settled strikes and brought labor peace by promising overly generous pensions for their employees when they retired. Defined benefit plans were the most common type of plan in those days and this is what most of these companies offered. They also agreed to continue their employer paid health coverage in these pensions. Managers at the time then attempted to keep costs down by making very liberal assumptions about future investment returns (i.e., assumed that returns would be greater than what turned out to be what they actually were). Now, years later, when the employees who were promised these overly generous plans retired the current managers were suddenly faced with skyrocketing retirement costs which they could not afford to pay. The result was that many large companies in the steel, airline and now the auto industries filed for bankruptcy to shed their pensions and get out from under the obligations. The government's Pension Benefit Guaranty Corporation had to take over these pensions and reduce them. This meant that retirees in their seventies and eighties suddenly found their monthly pension check reduced and, at the same time, were notified that they would have to begin paying part of their health care expenses.

As I pointed out in my Hub http://hubpages.com/hub/Bailing-out-Americas-Big-T , the American manufacturing sector in general and Detroit auto industry in particular are some of the most efficient companies in the world in terms of producing the highest quality product with the highest paid workers and the lowest production costs in the world. What has been killing them is not inefficiency or high wages but the huge cost of paying for these overly generous and underfunded legacy costs (i.e., their pension and retiree health care expenses).

As to Social Security, I pointed out in my Hub http://hubpages.com/hub/The-Social-Security-System that that program is not only NOT a pension plan but that the Supreme Court has twice ruled that Congress with a simple 51% majority vote can cancel that program at any time - the government can shed that program easily without having to go through bankruptcy.

thanks again for your comment.