Retirement: Defined benefit vs Defined contribution.. please help!

[kumquat]

I have to submit my final decision, which can never be changed again, before 2 p.m. (eastern) tomorrow. Any final words/recommendations are more than welcome because at this point, I still do not know what my final decision will be. I suppose it is a good thing that this decision is weighing heavily on me as most of the people my age could not care less about retirement savings whereas I am very concerned about my wife and I's financial independence in retirement.

If you plan to stay a long time (and think the payer of the pension won't renege on you) take the DB. If you are a realist, go DC.

If you take my advice, you are [-]a kumquat[/-] maybe someone who shouldn't ask anonymous idiots on the Internet what to do. If so, find better advise. My advice is worth what you paid for it. Cheque please.

 

[Lazarus]

If I were a young guy I would take cash in hand rather than a promise in the future. Advise from an older guy.

 

[donheff]

That is why the decision is so difficult and reading your post only makes me rethink what I should do. I almost wish I did not have a decision to make and only one option was offered.

Yeah, I didn't have a choice which worked out well since I ended up staying 31 years. But the odds are heavily against staying in one place for a lifetime - or even ten years. That would counsel the DC. Whichever way you go you should stop fretting about whether you leave a few bucks on the table. The fact that you are taking these issues seriously at 24 means you will be stashing a lot more under the table than 95% of your peers.

 

[Walt34]

As others have pointed out there are so many unknowables that at this point it's almost impossible to make the "right" decision. Like Leonidas, the 23-year-old me thought "Okay, they have a pension plan. That's nice. When can I start?" And that's about all the thought I gave to it for about the next ten years. But I kept the same employer for 29 years and had a variety of jobs.

Everyone sees life through the lens of their own experiences. That's why I'm tempted to say "Take the DB pension" but that's only because it worked for me. So far.

The other side of the coin is that at one time IBM had a terrific retirement plan and a lot of people got stung when the company changed the rules in the middle of the game.

So the answer is: "How lucky do you feel?" I think it safe to say that no one can predict with any certainty what the world will look like 30 years from now.

 

[ziggy29]

If I were a young guy I would take cash in hand rather than a promise in the future. Advise from an older guy.

There's merit to that, but don't forget that these tax-deferred retirement plans are based on a "promise" too -- that they won't be subjected to more punitive tax laws in the future, and that Roth IRA earnings (which were never taxed) won't be subjected to tax some day. Or that partially replacing an income tax with a VAT would largely negate the advantages of a Roth IRA. Or that at some point 401K balances won't be taken by the government in exchange for some form of "national pension plan."

So in the end, there simply are no guarantees. The cash really isn't "in hand" until it can be withdrawn from the retirement accounts.

 

[Rustic23]

If he is going to make $80k on his high 10 year, I took $70 as and average made over the 10 years. The you take 8% compounded for 25 years to get you to the 60, assuming you are 25 when things start, and you will have $719,000 in your account. That will give you $28,763 at a 4% SWR. Lots of assumptions in this, but I think the math is right. Biggest if, IMHO, is the $70 average salary for 10 years.

 

[nun]

The DC plan also has the benefit of giving you access to your capital. You can adjust your withdrawals whereas the with the DB plan you have no control.

Also check if your college/state offers a 457 plan. These are a slightly better option than the 403b as you can make withdrawals from them without a penalty after you leave the employer and before your 59.5.

 

[Independent]

Since it's Thursday, you've probably made the decision. Yet, I noticed that nobody has tried to crunch numbers. I thought I would do a little of that.

Vanguard says that $100,000 will buy a straight life annuity on a single 54 year old male paying $4,434 per year, increasing by a scheduled 3% per year. That's a little higher payout that the 4% SWR, but it has no opportunity for an estate, while the traditional 4% usually leaves a big estate.

So, I assumed you work for 30 years, get 4% annual raises, and try to match the DB plan by saving in the DC then buying the annuity at age 54. My calculations say you would need to earn 10.9% (nominal) to get there.

Of course, the DC plan looks better if you quit. You only need to earn 5.4% to match the benefit you'd get if you quit after 10 years, or 4.5% to match the benefit from 5 years work.

You may expect higher raises. I'm skeptical that they would continue for a lot of years, but here are the corresponding numbers for 6% annual raises: 12.9%, 5.7%, 4.6%

I'd point out that this is a pretty generous DB plan. Your employer could stop the plan relative to new contributions at any time. I don't know if they have a legal obligation to use raises you would get after they stop the plan when they calculate your benefit (the IBM people may know). If they don't, then your result is the same as if you quit voluntarily. Also, I'm assuming the age 54 retirement is available to someone who quits work early, again, I'm not sure if that is always the case.

Caveat: These numbers come from a worksheet I threw together pretty quickly. I've been known to make errors doing that. So, if you are interested in an analysis of this type I'd urge you to set up your own worksheet.

 

[ESRwannabe]

M477,

I had a similar decision to make roughly 10 years ago. I also had two options similar to what you have. I went with the pension option and I am vested. My reasoning was that the pension represented something I could not get otherwise anywhere else. I realized that if I wanted to invest in stocks and bonds I could do so on my own, which I have. I make around $54k a year and of that I invest $24k. I have been investing similar amounts for a few years now and plan to continue doing so.

At any rate, I am in a pretty good spot right now. Because I am a LBYM kind of guy I know that the pension can provide enough money for me to retire off of. If I put in another 20 years then at 60 I will be able to receive around 40% of my working salary every year with a 3% COLA (also fyi my pension provides no health benefits).

The pension has given me peace of mind. I know that when I get to 60 I will be able to retire no matter how the stock market is doing. Because of that I can invest aggressively (80/20 stocks/bonds) and feel no fear about it. However, in all likelihood I will not need to wait until 60 to retire, but instead will have sufficient investments to switch to contract or part time work in my 40s, with my investments providing half of my living expenses. That is the goal anyway.

So, I am really not sure what to recommend. The pension has been a nice security blanket but I doubt I will be putting in a full 30 years needed to really benefit from it. To be honest if you are a prodigious saver the pension is probably not worth while. It doesn't really provide much benefit unless you put in a full 30 years.

 

[haha]

I have a very important decision that will be set in stone after Thursday (April 1st).

Here is the decision I have to make:

My employer offers two different retirement options.

1. The Teachers Retirement System of Georgia (Defined benefit plan)

or

2. Optional Retirement plan. (Defined contribution plan)

I went to dinner and a movie last night with two ERs and their wives. One retired from a middling Federal job, the other from a state job.

They spend freely, take frequent trips, eat whatever they want from expensive shops. I am the only one with any significant savings, but I have a lot less to spend, and that is what counts. Add in retiree health care and you have a powerful combo.

Ha

 

[M477]

Thank you to everyone for sharing your experiences and suggestions.

I am going to go with the DB and set up my own personal DC. That way I can invest but still have a guaranteed income after 10 years. I really don't know if I will be here 10 years but I see no reason why I would not be. This school is probably the #1 employer in this area, the benefits are great, they will pay for my schooling etc. My and my wife's whole family live right around here so I have no reason to move.

The way I see it is that I am pretty confident that I will have to have a job for at least 10 years (barring that I win the lottery) .. why not make this my home? After 10 years I will be vested and that will bring some comfort around retirement age.

The decision is so tough because I want to know what the future holds and plan according to that, but unfortunately I do not have that luxury, only telephone hot-line psychics do.

Even if I do leave this employer after 7 years.. so what, it's just money, right? I would still be able to roll over my contributions (+ interest earned) from the DB which would be around 13k as opposed to the 38k with the DC. Sure, that is a 25k difference, but I see people make 20k mistakes all the time when they purchase new cars straight off of the lot and get stuck with a $400 a month car payment for 5 years, something I would never, ever, do.

Sure, that justification may not be the right way to look at it but there are risks in life and either choice brings its own share of them along with it.

I can look forward to having a second income equal to mine when my wife finishes college and that will provide more income for personal investments, I may as well go for a pension here since it is a rare opportunity (I think).

Thanks again to all of you for discussing this with me. You all seem like a very knowledgeable group of respectful people which is not always easy to find in the anonymity of the internet. I will plan on checking back at these boards as the topics here are of interest to me. I'm sure most of you are many years my senior but that is probably a good thing when it comes to retirement advice.

 

[Dreamer]

I am late to the party, but I receive a DB pension from the Fed Gov. My DH will be receiving a smaller pension from his employer. We can definitely live on these amounts. We have also saved on our own. Our savings is much lower than some on this board and more than some others. My knowledge on investing is much less than most on this board and I know that we would not have been able to retire early without our DB pensions. I hope that everything works out for you. You definitely sound like you are ahead of most of your peers.

 

[utrecht]

I suspect you and I are very different people, so you will have to take this with a grain of salt. However, there is no way I could imagine signing on the dotted line to stay anywhere for 10 years at age 24, let alone 30. Giving up your ability to move on if you get a better offer or simply don't want to do this job any more strikes me as a lot to leave on the table. I personally would take the bird in hand.

After all the recent discussion about how people with public (DB) pensions have it so good, statements like this one really surprise me. I don't know if Brewer is one of the ones who has been so critical of them or not, but I'm still surprised at how many people are putting caveats on taking the DB pension.

To me this is kind of like comparing two guys who come out of college. One guy takes a regular job, enjoys it and makes a good living. The other guy takes a huge risk and starts his own business. The business owner makes sacrifices, is broke for a few years but finally hits it big and ends up making more money than most people he knows. He took a risk, made sacrifices and it paid off. Now the first guy is jealous and wishes he had it so good, although he was never willing to go out on a limb and take the risks.

Everyone is constantly talking about how public employees have it so great in retirement with their DB pensions and if they had it to do all over again, knowing what they know now, they would choose a government job with job security and a pension. But when asked by this young guy who DOES have it to do all over again (for the first time), many people are advising him that the DB may not be the way to go. Brewer's reason is that he wouldn't want to sign on for 10-30 years with the same company. That's one of the very reasons why government employees have been rewarded with a nice pension. You cant have it both ways. You cant spend 30 years of your working life with the freedom to move around in the workforce, always free to take a better offer or to change careers when you feel the need to be rejuvinated.....and then at the end of the line, moan and groan that other people have a better retirement deal than you do when they endured the very things that you weren't willing to endure for 30 years.

Working for the government for 30 years sounds easy....until you have to actually do it. Fortunately for me, I have always loved my job (coming up on 20 years in a few months), but I know plenty of guys who have wanted to leave after 8-12 years but have felt trapped for many reasons including the retirement benefits. I'm quite sure when they put in another 15-20 years living with that feeling the whole time, they will feel like they deserve their sweet pensions and will resent it when other people act like they don't deserve it when those people weren't willing to do what they did for their community ( or country or city or college).

To the OP, clearly I would take the DB pension.

 

[ziggy29]

Everyone is constantly talking about how public employees have it so great in retirement with their DB pensions and if they had it to do all over again, knowing what they know now, they would choose a government job with job security and a pension. But when asked by this young guy who DOES have it to do all over again (for the first time), many people are advising him that the DB may not be the way to go.

Then there are those of us who *did* choose a (private sector) job with a DB pension and health insurance out of college and had it taken away after we'd invested a few of the most valuable years (in terms of accruing pension service for early retirement) there. In other words, I chose an option which, when hired in, allowed me to retire at 55 with full pension and retiree health insurance benefits (on an "85 point system"). No one can say I made my own bed by not choosing an employer with a pension. Ten years in, they took that deal away, and I'd never be 22 again and able to look for a position where I could get 30+ years in the pension and retire in my 50s (with health insurance, even).

My dreams of retiring with a juicy pension -- consistent with the decision I made out of college -- were taken away. Sure, I could have left for govvie work at that point, but even by the late 1990s many of the govvie plans had already watered down benefits for new hires. And I'd have to work well into my 60s to get enough of a pension to make it worthwhile (unlike my original plan where I'd be set at 55). And I had no reason to assume that government wouldn't change the rules, too. I felt burned, and it turned me more mercenary: get as much as I can while I know I can get it, because promises can be taken away.

So I would issue a cautionary tale to those just starting out today -- don't assume that the public sector will not turn out like the private sector. If the private sector tax base can not grow as quickly as public sector labor costs, the system *will* break (some would say it already has in some states and cities). At some point there will be no choice but to say "enough is enough" if the present situation persists with respect to the recent disconnect between private sector compensation and public sector compensation.

So I wouldn't say not to go for the pension, but I would say not to assume the deal you hire in with at 22 will be the same one you actually get at 60. Unless the private sector stages some sort of miraculous and sustainable growth spurt (unlikely based on global competition), the status quo simply can't be maintained much longer.

 

[donheff]

Utrecht: I cautioned the OP to be careful about taking the DB yet I am one of those who went with a 31 year Federal career and stuck with the old retirement system throughout. The fact is that most of my fellow Feds hires left after a few years and could only pull out their input with no interest and no match. The fact is that most of the OP's coworkers at the school will leave in a few years. I agree with Brewer. Had I a choice between a completly non-portable DB when I started and a fully portable 401K with match, I would have chosen the 401K. In the current environment with pensions being scaled back or cancelled I would be even more cautious about the DB. This has nothing to do with second guessing peoples' career decisions. It has to do with evaluating the impact of financial choices. Whichever choice the OP made on Thursday he had already made his (initial) career decision and I didn't hear anyone second guess him on that.

 

[utrecht]

donheff,

That is one of the reasons that I don't completely buy into the fact that public pensions are going to break the back of governments. The data that is used to calculate how fully funded a pension is is faulty. Those figures are based on worst case scenarios and assume that everyone within the system with collect a full pension, when in fact that percentage of people who stay and collect anywhere near a full pension is very small.

Every time someone leaves before they are vested, they take out their contributions but the employer contribution stays in the fund and grows forever. Also, a lot of people leave after vesting and are foolish enough to take their money out. Those people take theirs and the employers contributions but the plan never has to pay them a cent in the future.

If everyone who hired on stayed for 30 years and was paid a full pension, then I'm sure most public plans would go bust, but that's never going to happen. The whole thing is overblown in my opinion.

My point is that if you are correct (and I agree with you) that most new hires will leave after a few years and pull out their contributions with no match and they don't ever collect a generous pension, then how in the world are DB pensions really going to be the end of society as we know it as everyone seems to think?

 

[donheff]

My point is that if you are correct (and I agree with you) that most new hires will leave after a few years and pull out their contributions with no match and they don't ever collect a generous pension, then how in the world are DB pensions really going to be the end of society as we know it as everyone seems to think?

Could be but I thought we were reacting to people cautioning the OP to be cautious about choosing the DB over the DC. Statistics counsel that OP will be one of the many who move on thus the DC may be the prudent choice. On the other hand, if the differences are not great and the OP believes he has a better chance than most of staying put (he did mention family and other considerations) it may be prudent to go that way.

Hey OP -- what was you final choice? I don't remember seeing the answer.

 

[Meadbh]

He went with the DB: see Post #36.