Many Americans believe that a retirement security crisis is looming; they feel it in their daily lives. Many Americans also believe that one of the benefits of a lifetime of hard work should be a secure retirement. The question for both employers and employees then is how best to provide that secure retirement. While conservative politicians and anti-pension ideologues would say that defined contribution, 401(k)-style accounts can provide a secure retirement, the truth is that defined benefit pensions provide the safest and most secure retirement for working families.
Here’s a look at some of the basic differences between defined benefit and defined contribution plans:
Who bears the risk?
- Under a defined contribution plan, the risk is carried entirely by the employee. Someone could work for 30 years saving for retirement and then lose it all in a stock market crash just before their planned retirement.
- Under a defined benefit plan, the risk is shared among everyone paying into the pension. Yes, the stock market moves up and down; some years investment returns are strong and some years they are weak, but as long as people are paying into the pension fund, those variations can be smoothed out and no one has to bear the brunt of a stock market downturn by themselves.
Who manages the money?
- Under a defined contribution plan, individual workers are responsible for managing their own retirement. Since most workers are not financial planning experts, they rely on financial advisors to manage their 401(k)’s and these Wall Street firms earn significant fees off managing these investments.
- Under a defined benefit plan, the pooled assets are professionally managed by pension administrators, which keeps costs low. Also, individual workers do not have to worry about trying to understand the intricacies of financial markets and can be confident that their contributions to their pensions are being well-managed.
What does it cost?
- Defined contribution plans are often sold as a less expensive retirement option than defined benefit pensions. However, a study by the National Institute on Retirement Security found that it costs nearly twice as much under a defined contribution scheme to offer the same benefit as under a defined benefit pension.
- Defined benefit pensions are cost-effective because they are collectively pooled assets that are professionally managed.
Defined contribution plans fail to provide retirement security to working families and are a huge boon to Wall Street financial firms, which can make millions off the fees they charge to manage 401(k) accounts. It’s no wonder that hedge funders like John Arnold want to force public workers into 401(k)-style accounts – they stand to profit while public workers stand to lose. Fortunately, states have been rejecting attempts to gut defined benefit pensions for the past several years.