Reality of choosing DC over DB plan

[nun]

Nine years ago I started work for a state government and chose a DC plan over the state DB plan because I'm at the tail end of my career and didn't know if I'd stay in the job to get to the 10 year DB vesting. Both the plans are funded identically - 11% employee contribution and 4.5% state contribution. Well it looks as if I'll make 10 years now so I compared the relative size of my DC to the DB benefit.

Over the nine years my DC plan has averaged 6% annual return. It's in a 50/50 mix of low cost index funds.

If I project the principal in my DC plan to age 55 (the age that I would have be eligible for the DB income) using 6% return and 3% inflation for the COLA I would need a WR of 6.5% to match the annual income I would have been eligible for from the DB plan. The DC plan goes to zero balance after 26 years and of course the DB plan lasts until I die.

 

[ziggy29]

I think the ideal retirement plan would have both DB and DC components anyway, to create something closer to the "three legged stool" approach to retirement (which is why I've long been a proponent of the FERS model). Ideally the DB pension and SS would be enough to ensure at least a modest retirement where all basic needs are met at minimum, and the DC component would be the individuals choosing to defer creature comforts today in order to create a more comfortable retirement than that.

 

[nun]

......here are some number for comparison.

I'm 52 and my current DC principal is $254k. If I retire now and project to age 55 (when I would have been be eligible for the DB pension) using 6% return the DC principal will be $302k. The DB COLAed annual income (FYI the DB plan only has COLA on the first $13k) would be $19.5k so I'd need a WR of 6.5% from the DC plan to match that and with a 6% return and 3% inflation the DC balance would be 0 after 26 years. This is close to the 25 year life expectancy of a 55 year old male, so the DC and DB plans are actuarially similar as long as the DC averages 6% return. Of course if I live past my expected life time the DB plan wins.....but that's common knowledge.

If, however, I bought a SPIA with the $302k at today's rates I'd get a non-COLA $16.4k a year.

 

[brett]

DB will always yield more than taking the cash value and converting it to an annuity. DB folks have a lower life expectancy because of the mix . Annuity folks have a longer projected lifespan (because people with excellent health and longevity in their families are more liable to buy them than those who do not, ie the general population mix).

I think the DB choice is a function of your entire retirement portfolio and plans. There is a certain degree of comfort knowing that a base amount of your retirement income a known factor.

 

[nun]

DB will always yield more than taking the cash value and converting it to an annuity. DB folks have a lower life expectancy because of the mix . Annuity folks have a longer projected lifespan (because people with excellent health and longevity in their families are more liable to buy them than those who do not, ie the general population mix).

I think the DB choice is a function of your entire retirement portfolio and plans. There is a certain degree of comfort knowing that a base amount of your retirement income a known factor.

Interesting.

If I'd been able to see into the future back in 2004 when I chose the DC plan over the DB plan I would have gone with the DB. Having a guaranteed and COLA'ed $19.5k from 55 until I die would have been great. With the DC I'll get that if I manage 6% return and die on schedule. I'll have to die early so I can leave some money to my heirs to feel good about the DC choice.......wait a minute, what and I saying?

 

[brett]

I would, and did, go with a DB plan.

And I was very happy that I did not switch from DB to DC in 1999 when it was offered.

 

[Katsmeow]

I think the ideal retirement plan would have both DB and DC components anyway, to create something closer to the "three legged stool" approach to retirement (which is why I've long been a proponent of the FERS model). Ideally the DB pension and SS would be enough to ensure at least a modest retirement where all basic needs are met at minimum, and the DC component would be the individuals choosing to defer creature comforts today in order to create a more comfortable retirement than that.

DH basically had this at his Megacorp. He was eligible for a traditional pension, plus he had a 401K plan that Megacorp matched up to 6% each year.

Of course, DH worked at Megacorp for over 30 years and the DB plan was no longer available to newer employees by the time he retired.

I still remember when he and I got married a little over 20 years ago. At the time I made over twice what he did and, I remember at one point commenting to him that I didn't think his job compensation was very good. (This was early in our marriage when I was still an idiot). I remember him explaining to me why his job was very good and better than mine.

DH, made about half what I made. However, his benefits were light years better than mine. And he had not only the 401(k) match but was in line for a pension which he could either as a pension or as a lump sum. I didn't realize for years just how valuable that was. I had some vague idea he would get some trivial pension and didn't even realize he could take a lump sum. A few years before he retired I found out he could take a lump sum and it was several hundred thousand dollars. And then he lucked out. His compensation went up tremendously his last few years at the company (so he was up to about 75% to 80% of my compensation) and the pension was based on the last 3 years. So a $600k lump sum increased to over a million in a matter of a couple of years. Obviously just made a huge, huge difference and enabled him to retire at 62.

 

[Walt34]

And I was very happy that I did not switch from DB to DC in 1999 when it was offered.

You and many others, myself included. Back when the feds changed from CSRS to FERS my employer did much the same thing and offered current DB plan holders the option of changing and getting back half of their retirement contributions. Many of them did, and bought cars, boats, etc.

They sure are regretting it now.

 

[nun]

You and many others, myself included. Back when the feds changed from CSRS to FERS my employer did much the same thing and offered current DB plan holders the option of changing and getting back half of their retirement contributions. Many of them did, and bought cars, boats, etc.

They sure are regretting it now.

If you were vested in the DB plan it would have been dumb to exchange it for a DC plan.

Ten years ago I chose the DC plan over the DB because my average tenure in any job was 7 years and I was 42 so I wasn't sure that I'd be in the job long enough to vest in the DB plan. This highlights the only real advantage I see in a DC plan over a DB plan, the flexibility and immediate vesting of employer contributions. Ten years ago the DC plan was the correct choice for my circumstances. Now that I'm 9 months away from vesting the DB choice would have been best. I'd gladly exchange my potential $302k DC pot for the guarantee of $19.5k COLAed for the rest of my life.

 

[utrecht]

Just because it worked out this way for you and you did stay 10 years, it doesn't mean you made the wrong decision. You weighed the pros and cons at the time and made your decision. You could just as easily have chosen the DB plan and then left after 8 years and you would be posting about how you wished you had chosen the DC plan.

Let's say you're a baseball manager. There's a man on first who can successfully steal 2nd base at a rate of only about 33%. You don't tell him to steal and the pitcher throws the ball in the dirt so he could've stolen on that pitch. The next batter gets a hit which sends the runner to 3rd when he would've scored if he had stolen 2nd base. That doesn't mean not stealing was the wrong move.

There's no need to worry about decisions that would've worked out better had you gone a different way when you know you made the correct decision with the info you had available to you at the time.

 

[brett]

Some of my colleagues who took the DC option in 1999. They got hammered in the 2000/2001 crash and then got hammered again in the 2007/2008 crash. Others are still happy that they went with DC.

One thing for certain in my case. The 7 year projections that showed the DC plan as being slightly better than the DB plan were based on an implicit return of 7.5 percent. I suspect that some folks who moved to DC were fortunate to break make 4 points, let alone 7.5.

That was the gamble that I was not prepared to take-even given the great market performance in 1998/1999.

 

[nun]

Just because it worked out this way for you and you did stay 10 years, it doesn't mean you made the wrong decision. You weighed the pros and cons at the time and made your decision. You could just as easily have chosen the DB plan and then left after 8 years and you would be posting about how you wished you had chosen the DC plan.

Sure, like I said, when I made the decision it was the right one, but the DB plan would be best now. It is instructional to now compare my DC plan to the DB and see that I've basically matched the DB plan performance with a 6% return.....but I don't have the pool of other people to share the mortality risk to give me a lifetime benefit. So if I live longer than expected the DB plan will win out and if I die early the DC plan will have been a lot better...at least for my heirs.

 

[ERhoosier]

Just because it worked out this way for you and you did stay 10 years, it doesn't mean you made the wrong decision....

Let's say you're a baseball manager. There's a man on first who can successfully steal 2nd base at a rate of only about 33%. You don't tell him to steal and the pitcher throws the ball in the dirt so he could've stolen on that pitch. The next batter gets a hit which sends the runner to 3rd when he would've scored if he had stolen 2nd base. That doesn't mean not stealing was the wrong move.

+1, although I prefer a simpler analogy. If I'm at a casino watching Roulette, I REFUSE to kick myself for not having bet my entire retirement nest egg on 35-Black after the ball stops on that number

 

[Gearhead Jim]

Interesting.

If I'd been able to see into the future back in 2004 when I chose the DC plan over the DB plan I would have gone with the DB. Having a guaranteed and COLA'ed $19.5k from 55 until I die would have been great. With the DC I'll get that if I manage 6% return and die on schedule. I'll have to die early so I can leave some money to my heirs to feel good about the DC choice.......wait a minute, what and I saying?

Your DC investment returns will be variable, and perhaps not so good.

But in today's world, there is no such thing as a "Secure" DB plan.

 

[nun]

Your DC investment returns will be variable, and perhaps not so good.

But in today's world, there is no such thing as a "Secure" DB plan.

Yes Yes, over the past 10 years I've averaged 6% return in the DC plan. That given me a DC principal that is actuarially equivalent to the DB plan as long as I keep getting 6%. The return is obviously variable and without knowing that it's impossible to know what plan will have been better after 25 years of retirement. The DB plan is as secure as they get as it's a state plan that has already gone through a set of reforms and the state has pledged to keep the current plan for all current employees. But that's of no concern to me as I have the DC option.

 

[nun]

Yes Yes, over the past 10 years I've averaged 6% return in the DC plan. That given me a DC principal that is actuarially equivalent to the DB plan as long as I keep getting 6%. The return is obviously variable and without knowing that it's impossible to know what plan will have been better after 25 years of retirement. The DB plan is as secure as they get as it's a state plan that has already gone through a set of reforms and the state has pledged to keep the current plan for all current employees. But that's of no concern to me as I have the DC option.

Well I just learned that in the 2011 Pension Reform Act MA included a provision to transfer from the DC retirement plan to the DB plan. However, it needs a ruling from the IRS and they are being very very slow in addressing the issue and then they might nit allow it.

 

[Texas Proud]

DH basically had this at his Megacorp. He was eligible for a traditional pension, plus he had a 401K plan that Megacorp matched up to 6% each year.

Of course, DH worked at Megacorp for over 30 years and the DB plan was no longer available to newer employees by the time he retired.

I still remember when he and I got married a little over 20 years ago. At the time I made over twice what he did and, I remember at one point commenting to him that I didn't think his job compensation was very good. (This was early in our marriage when I was still an idiot). I remember him explaining to me why his job was very good and better than mine.

DH, made about half what I made. However, his benefits were light years better than mine. And he had not only the 401(k) match but was in line for a pension which he could either as a pension or as a lump sum. I didn't realize for years just how valuable that was. I had some vague idea he would get some trivial pension and didn't even realize he could take a lump sum. A few years before he retired I found out he could take a lump sum and it was several hundred thousand dollars. And then he lucked out. His compensation went up tremendously his last few years at the company (so he was up to about 75% to 80% of my compensation) and the pension was based on the last 3 years. So a $600k lump sum increased to over a million in a matter of a couple of years. Obviously just made a huge, huge difference and enabled him to retire at 62.

Your last sentence is the reason that most DB plans are being closed.... there is very little connection to the amount paid in by an employee and the amount received... IOW, somebody had to come up with that extra $400K... contributions over the years was for a $600K balance... working 3 years at a much higher salary does not put in enough to make up that $400K... it is great for you and your DH, not so much the taxpayers....

 

[MichaelB]

Your last sentence is the reason that most DB plans are being closed.... there is very little connection to the amount paid in by an employee and the amount received... IOW, somebody had to come up with that extra $400K... contributions over the years was for a $600K balance... working 3 years at a much higher salary does not put in enough to make up that $400K... it is great for you and your DH, not so much the taxpayers....

The way I see it, the increase in benefit over the last few years is an indication that the benefit is under-vested up to that point. IOW, the increase from year 27 to year 30 is a sign that at year 26 the benefit is too low compared with the final value. This is characteristic of DB plans in general and one reason companies like to aim RIFs at the over-45 types.

DB plans were closed because they are less costly for employers and much of the resources had already been sucked out. Not sure what it has to do with taxpayers, these are private employeers.

 

[ziggy29]

DB plans were closed because they are less costly for employers and much of the resources had already been sucked out. Not sure what it has to do with taxpayers, these are private employeers.

Indirectly, it does involve taxpayers. Many private businesses are paying less in corporate income tax (and often flirting with bankruptcy) in large part because of their pension obligations. When that happens, tax revenues fall at a time when need for services (the safety net for the mass layoffs they create) is rising.

That said, you can say that about any kind of mismanagement, too -- not just DB pension plans which were often either (a) underfunded or (b) overpromised on benefits with expectations of unreasonably high returns.

 

[MichaelB]

Indirectly, it does involve taxpayers. Many private businesses are paying less in corporate income tax (and often flirting with bankruptcy) in large part because of their pension obligations. When that happens, tax revenues fall at a time when need for services (the safety net for the mass layoffs they create) is rising.

That said, you can say that about any kind of mismanagement, too -- not just DB pension plans which were often either (a) underfunded or (b) overpromised on benefits with expectations of unreasonably high returns.

OK. But you are referring to a situation where corporate mgm't is exploiting accounting and tax regs and walking the narrow grey line. A fair point. My comment referred to the average DB plan. Even though the benefit jumped up over the final couple of years, that is not how most corporations accounted for the pension. More often than not the accrual was higher, closer to a straight line than exponential curve. IOW, the tax books reflected a greater pension accrual. Ironically, the greater level of funding, even just book accounting, is what led many to do away with the plans or RIF the employees, because that came back onto the financial statements as profit (reversal of prior years expenses).

 

[ziggy29]

OK. But you are referring to a situation where corporate mgm't is exploiting accounting and tax regs and walking the narrow grey line. A fair point. My comment referred to the average DB plan. Even though the benefit jumped up over the final couple of years, that is not how most corporations accounted for the pension. More often than not the accrual was higher, closer to a straight line than exponential curve. IOW, the tax books reflected a greater pension accrual. Ironically, the greater level of funding, even just book accounting, is what led many to do away with the plans or RIF the employees, because that came back onto the financial statements as profit (reversal of prior years expenses).

Agreed, and I include that as a form of "mismanagement". When a pension plan overpromises benefits (and when it has a huge "spike" in obligations above 30-40 years of service), it has a vested interest in whacking all the old-timers, whereas with a more linear payout scheme (i.e. 20 years gets 2x more than 10 years, 30 years gets 3x more than 10 years, et cetera) that incentive would be reduced. It usually seems close to linear but many plans have a "magic number" at which point it suddenly becomes a *lot* more lucrative. Think about how many times you hear someone say they need to hang on until (insert date here) because it will make a huge sudden difference in their pension.

I guess once upon a time retention of the older and more experienced folks was seen as a net positive for businesses; now they treat that as a liability that needs to be excised like a corporate tumor.

 

[brett]

In my experience, megacorps target older workers not simply because of the rising costs of DB pensions. The entire employee cost envelope is considered...salary, benefits, vacation, illness. Everything. The cost envelope to bring in youger staff is typically much less.

Many megacorps actually self fund for medical/benefits. They pay a third party to manage it for them.

A few of the large HR/Benefit consulting companies have models that provide megacorps with the most 'cost efficient' age groups to downsize based on salary and benefits.

I know of at least one megacorp that has implemented recommendations from a consulting company like this and realized the cost savings. But the cost savings were fleeting due to severe decreases in employee morale, productivity, and the ability to attract talent.

 

[ziggy29]

A few of the large HR/Benefit consulting companies have models that provide megacorps with the most 'cost efficient' age groups to downsize based on salary and benefits.

And a team of lawyers to find excuses as to why this doesn't constitute illegal age discrimination, where workers between the ages of 40 and 70 are "theoretically" protected.

 

[brett]

They have a much nicer, inocuous name for it but the bottom line is the same. Input the parameters, run the program, and the name, ee numbers etc. and the results pop out in order of payback. The rest is up to management discretion.

If you are in a management/supervisory position in a company that regularly downsizes you may be accustomed to the usual... please cut your headcount by X headcount, X dollars, whatever. Just give us a list of the names.

If this changes and the company gives you a list of ees to downsize instead of having you selecting them this is a good indication that something other than your judgement is at play.