The Pension Problem

The retirement benefits of government workers have been in the news a lot lately. I've heard more noise than substance. Today I want to talk about some of these plans and why they are a problem in need of a solution.

Retirement plans come in two flavors: defined benefit or defined contribution. To understand the problem, you need to understand the difference between the two. If you already understand the difference, skip the next two paragraphs!

With a defined contribution plan you contribute every month to a tax-deferred retirement plan--like a 401(k) or 403(b). Your employer may match some or all your contributions or otherwise contribute to the plan on your behalf. After a few years (usually seven) you are 'vested' and the employer-provided portion belongs to you. Then you keep working until you save up enough money to last until you die.

With a defined benefit plan, the employer promises to provide a salary for life. Depending on the plan, you may or may not be required to contribute a portion of your earnings. Generally you work for so many years and then receive a retirement benefit based on a formula, such as the average of your three highest years of earnings. Most plans also include annual cost of living increases.

Defined benefit plans came about at a time when most people tended to work for the same employer for life. The plans were cheap for employers because few workers lived to retirement age. Those who did live long enough to retire tended to die shortly thereafter. The dramatic increase in life expectancy over the last five decades made defined benefit plans huge liabilities for employers.

Many defined benefit plans allow workers to retire after 30 years of service. Start the job at 22 and retire 30 years later and you will easily cost the employer more in retirement than you did when you worked. When that employer is a city, county, state or federal entity, the rest of us foot the bill.

Today defined benefit plans survive primarily in the government sector and in selected industries with strong unions. A few large corporations with defined benefit plans and strong unions were forced into bankruptcy. Everybody else shifted to defined contribution plans years ago.

Solving the pension problem is tricky. Nobody wants out of a defined benefit plan. Unless other provisions are made for individuals approaching retirement, it's not fair to just pull the rug out from under older workers.

Part of the solution is to require workers under a certain age (say 30) to participate in a defined contribution plan. When it comes to saving, time is definitely on your side. Defined contribution plans offer an incentive because the more you save, the sooner you can quit working.

In the spirit of full disclosure, I have both types of plans. Most my retirement income (unless my book hits the bestseller list)will come from money stashed consistently over many years in one of several tax-deferred accounts. In addition to Social Security, I have ten years of federal service from a prior job that will likely add less than a couple of hundred dollars a month to my retirement income.

I'll admit the idea of having to save up enough money for a comfortable retirement was intimidating. Having now contributed to a tax-deferred retirement plan for more than three decades, what once looked impossible is now within reach. Retirement is more than just a dream for...

The Crotchety Old Man