Educators' Defined Benefit Pension Plan - What's so Good about it??

There are two types of pension plans: defined benefit and defined contribution. Educators, and others (fewer by the minute) have defined benefit pensions, while most other (corporate) employees have defined contribution plans.

I often hear the question, "What's so great about my defined benefit plan? What's the difference between it and other pension plans?" This article will attempt to clarify the differences between the two plans, as well as highlight some of the benefits (no pun intended) of the defined benefit plan.

Defined Contribution pension plans are plans in which the employee sets aside (contributes) money, often pre-tax (like the 403(b)), which will hopefully grow to a sizable sum for retirement. It is called defined contribution because there is a set maximum an employee can contribute. Sometimes the employer will also contribute (match a 401(k), for instance). Some examples of defined contribution plans include 401(K) plans, Roth 401(k) plans, employee stock ownership plans and profit sharing plans.

Defined Benefit pension plans are plans in which the employer sets aside money for the benefit of the employee at retirement age. It is called a defined benefit plan because the benefit amount is predetermined; a participant is told what pension amount will be available. The amount the employer sets aside is based on an actuarial formula that takes into account the age of the employee, the anticipated retirement date, years of service, mortality tables, salary, and so on.

The advantages of Defined Benefit Plans are: They provide employees a guaranteed retirement income, no matter what happens in the stock market, how long an employee lives after retirement, or whether s/he becomes disabled. There is no investment risk to participants (the employer takes on the risk - if the investments lose, the employer is still liable for the pension), there are annual cost of living adjustments to account for inflation, death and disability insurances are typically provided, and the pension is not dependent on the participant’s ability to save. With this type of pension, a participant is generally not required to make contributions and unlike defined contribution plans, the participant is not required to make investment decisions. A defined benefit plan is sometimes referred to as a fully funded pension plan.

The advantages of Defined Contribution plans are: They are a tax deferred retirement savings program, participants have control, within limits, as to how much they choose to save, the investments can be funded through payroll deductions, and participants can make their own decisions as to where to invest their money (and if they chose well, or were "lucky", they reap the benefits of those choices).

The bad news is that defined contribution plans provide no insurance benefit in case of an employee's death or disability; employees must purchase this coverage at additional cost. In addition, the participant bears the investment risk. If their investment choices don't fare well, they may come up short at retirement. This could happen, too, if they didn't contribute enough during their earning years.

The reason defined benefit plans are fewer and farther between these days is because they are very expensive to administer, and costly to fund. Employers are choosing to use defined contribution plans for their employees because of low administrative costs, and low funding requirements. Some employers who have defined benefit plans already in place are switching to the less costly Cash Balance Plan, which resembles a defined benefit plan, but costs much less.

Remember, a defined benefit plan gives all the investment risk and responsibility to the employer. It's a very good pension to have. For teachers, the defined benefit plan is oftentimes a state pension plan, such as the State Teachers' Retirement System. And teachers can not only rely on their defined benefit pension, but can use their 403(b) accounts, IRAs, and Roth IRAs to supplement their pensions.

California State Teachers' Retirement System

In your corner. Tina Anders