Saturday, December 20, 2014

The Defined Benefit Hoax

There has been a long standing debate about which pension plan is best for workers -- "defined benefit" or "defined contribution." 

A db (defined benefit) plan is like the US social security plan.  It simply promises to pay specific amounts of money defined by worker income history and other data.  The issue of where the money comes from to fund the promises is left hanging.

A dc (defined contribution) plan is like an IRA plan.  It receives contributions during working years.  Those contributions are invested.  Ultimately, the contributions plus their accumulated earnings become available for retirement or for any other purpose (such as bequests to the next generation).

The real difference between these systems is that a db plan can become "unfunded," while a dc plan cannot become "unfunded" (by definition).

Supporters of db systems have always claimed that such plans (most public employee systems such as those for public school teachers and state and local government employees are db plans) are "guaranteed."

Detroit public employees recently found that the "guarantee" is nonsense.  All db plans can have the benefits revised or eliminated, contrary to what supporters of db plans claim.  As everyone knows, social security will never be able to pay the benefits currently written into law for future beneficiaries.  Huge, largely unexpected, benefit cuts await most future social security recipients.

In today's Washington Post, Michele Singletary, an outstanding financial advice columnist, notes that Congress last week formally opened the way to cutting db benefits for multi-employer db plans: "Tucked into the federal spending bill were provisions that allow certain struggling multi-employer pension plans to reduce benefits already being received by retirees."

Read that last sentence again.  For folks already retired, this new law allows the plan to cut payments.

So much for the main argument for db plans.  When the money they are supposed to provide is needed for retirees, they, like Lucy, can simply pull the football away and let Charlie Brown kick the air.

Db plans were built on a foundation of hope, optimism and misrepresentation.  Only dc plans will be fully funded.  Those who expect to survive on db plans will be disappointed (and impoverished).

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