Defined Benefit vs. Defined Contribution Plans
This terminology is critical to understand. If you really stop to think about the terms, they reveal exactly what they mean. Retirement plans may be classified as defined benefit or defined contribution according to how the value of the investments or the future benefits is determined.
Defined Benefit (DB)-This is what PERA and most statewide public employee pensions are for the most part. A defined benefit plan guarantees a certain payout at retirement, according to a formula that takes into account the member’s salary and the number of years’ membership in the plan. The defined benefit calculation allows for PERA to weather short-term “ups and downs” of the investment market in order to create a predictable payout upon retirement. A defined benefit plan is sometimes called a pension.
Defined Contribution (DC)-A defined contribution plan provides a payout at retirement that is dependent upon the amount of money contributed and the performance of the investment vehicles utilized minus fees. A commonly known type of defined contribution account is a 401(k). These investments are individually based, and fluctuate according to market conditions.
Here is a one pager by the National Public Pension Coalition (our national partner) on the differences between DB and DC plans.
What does this all mean in the PERA policy conversation?
- PERA is primarily a defined benefit program, which provides a secure, predictable retirement for public employees. Keep in mind that most PERA members do not participate in Social Security, so their PERA retirement benefit may be their only source of income in retirement.
- Some say that PERA should become a defined contribution program, but moving to that model in lieu of the current defined benefit plan would require an annual state payment in the billions. It just does not make fiscal sense.
- What is sometimes missing from the policy discussion related to retirement plan structure or the DB/DC debate is the potential cost of keeping elderly Americans out of poverty. Research has shown that poverty rates among older households lacking pension income are about six times greater than those with such income. (Source: NIRS)
- Defined contribution plans, such as 401(k) plans require management and oversight by the account holder. As the person nears retirement, there is a risk that investments that fluctuate downward, such as in the 2008 market crash, would not recover to allow a secure retirement.