According to a report from the National Institute on Retirement Security (NIRS), when given the choice between a defined benefit or defined contribution plan, public employees overwhelmingly choose the defined benefit pension plan. As New York State & Local Retirement System (NYSLRS) member, you’re covered by a defined benefit plan.
Defined Benefit Plans
According to the Internal Revenue Service (IRS), defined benefit plans provide a fixed, pre-established benefit for employees at retirement. The defined benefit plans administered by NYSLRS:
- Provide a guaranteed lifetime retirement benefit;
- Offer a pension that is based on final average salary and years of service;
- Provide a right to pension benefits (vesting) after accruing five years of service credit (ten for Tier 5 and 6 members);
- Build a cost-of-living adjustment (COLA) into pensions to partially offset the effect of inflation after retirement;
- Include disability benefits and death benefits;
- Favor long-term public employment because pension amounts are related to years of service.
Defined Contribution Plans
The IRS describes a 401(k)-style defined contribution plan as a retirement plan in which the employee can make contributions from his or her paycheck either before or after tax, depending on the options offered in the plan. The contributions go into a 401(k) account, with the employee often choosing the investments based on options provided under the plan. In some plans, the employer also makes contributions such as matching the employee’s contributions up to a certain percentage. The most common employer matching contribution is 50 cents for the first 6% saved by the employee.
If an employee changes jobs, he or she can choose what to do with account. The employee can:
- Leave the 401(k) money where it is;
- Roll it into an Individual Retirement Account or another 401(k); or
- Cash out the account.
At retirement, the retiree is usually left to decide how to spend his or her retirement savings based on the balance in his or her account. Since the value of the account will fluctuate due to investment gains and losses, unlike a defined benefit plan, defined contribution plans may not provide a reliable monthly benefit at retirement.
In addition, defined contribution plans do not provide death and disability benefits to survivors. If they are provided, the employee may be required to make extra contributions to a structure outside the defined contribution plan.
Cost Effectiveness Comparison
Numerous studies have shown that defined benefit plans cost less in the long run than 401(k)-style defined contribution plans and perform better. In fact, according to the model in a recent NIRS report, defined benefit plans cost 46% less than individual 401(k)-type defined contribution plans for several reasons:
- Defined benefit plans avoid longevity risks. An individual investor in a defined contribution plan needs to plan for a long life expectancy, and must save at a rate that ensures that their funds will last well into their nineties to avoid running out of money. Defined benefit plans save for average life expectancy. As a result of this longevity risk pooling, defined benefit plans achieve a 15% cost savings over defined contribution plans.
- Defined benefit plans can maintain an optimal asset allocation. Financial advisors urge individual investors to make higher risk investments with higher returns when they are younger, and shift to lower risk investments with lower returns as they age so their funds will last through their retirement. But because defined benefit plans do not age, unlike the individuals in them, they are able to take advantage of the enhanced investment returns that come from a balanced portfolio over long periods of time.
- Defined benefit plans achieve higher investment returns. Professional management and lower fees result in a 1% annual increase in investment returns over an individual’s career. That amounts to a 26% cost savings for defined benefit plans over defined contribution plans.
By administering a reliable, cost efficient and sustainable defined benefit plan, NYSLRS provides its members with the means to help ensure their financial security in retirement. To find out the specifics about your retirement benefits, please read your retirement plan publication.