Retirement Savings Options, Part I

I’ve been doing a good bit of retirement-related math over the past week or so. With a new job comes new retirement options. The first decision that I need to make is whether to choose my employer’s defined benefit or defined contribution plan. The defined benefit plan (basically a pension) is the ‘safe’ play in that it guarantees a set amount in retirement — after 30 years I’d retire at 60% of the average of my highest two years’ salary, and there’s the possibility that I could buy additional credits that would increase my payout between now and then.

The downside to the defined benefit plan is that this payout rate doesn’t come with survivorship benefits. Given that my wife is a stay-at-home mom, she’ll be pretty dependent on my retirement income, and thus we need survivorship benefits. Unfortunately, this will reduce the payout rate by about 20%, down to 48% or so of the average of my highest two years’ salary. While pensions have gotten a bad name in recent years, this plan is particularly well-managed, and is actually overfunded right now, so I’m not to worried about that. My contributions to this plan would be 5% of salary going forward.

Under the defined contribution plan, I would likewise contribute 5% of my salary going forward, but this would go into a 401(k)-like account into which my employer would put an additional 8-10% (it’s varied a bit over time, but it’s currently at the lower end of that range). I would then be on my own to turn this into a fortune (or not).

The key remaining difference between the two is that it takes ten years to vest in the defined benefit plan, whereas I would vest immediately in the defined contribution plan. This actually sounds like a bigger difference than it really is. Without getting into too much detail, I’ll just say that I have complete job stability, and I’m perfectly comfortable with the notion of remaining here through the vesting date (and beyond).

In addition to the above, I have the option of participating in a 403(b), which is a tax deferred retirement account, to the tune of as much as $15k/year. We are also maxing out our Roth IRAs each year, and now have the option of setting up a SEP-IRA to receive ’employer’ contributions from my self-employment income.

Returning to the issue at hand, I set up an Excel spreadsheet the other night to run a comparison between the defined benefit and defined contribution plans, and found that the latter will hold out for 26 years after retirement if I draw it down at the same rate as the defined benefit plan will be paying out. In other words, if my wife or I (or both) live more than 26 past my retirement, we’d come out ahead with the defined benefit plan. Note that this scenario was run assuming survivorship benefits for my wife — the comparison would tilt more clearly in favor of the defined benefit plan if we didn’t need this option.

Obviously, I made a number of assumptions here. But I held the assumption steady between the two plans wherever possible, so this should be an as close to an apples-to-apples comparison as I can get. The biggest thing that could throw this off is the assumed rate of return in the defined contribution plan — I based my calculations for this plan on an 8% pre-retirement and 6% post-retirement return.

I’m currently leaning toward the defined contribution plan. Any thoughts?

See also: Retirement Savings Options, Part II

9 Responses to “Retirement Savings Options, Part I”

  1. Anonymous

    Defined Benefit plans are for suckers. A 401k or equivalent is a property interest. It belongs to you, regardless of what happens to you or the company you work for in the future.

    In an era when the default assumption was that a person would stay with a single employer for most of their career, and that sufficiently large companies were immune to the laws of economics and history, it’s easier to see how people fell into the DBP trap. But now we know better. Any company can go bankrupt. Any company with control over its employees’ retirement funds will abuse that power. Don’t let it happen to you.

    With the DCP, you’re absolutely guaranteed that your account will be there for you, regardless of when or under what circumstances you leave the company. Not so with the DBP.

    You might as well base your retirement planning on lottery tickets as a traditional pension.

  2. Beck, thanks for the clarification. Again, I can’t (or rather won’t) go into more detail with regard tomy employer, but in my case it really is true — at least the first part of it. That being said, there certainly is value in flexibility, and the latter half of that statement (my comfort with staying put) may well change.

  3. Anonymous


    I would hesitate to say that the defined benefit (pension) plan is the “safe” play. You may also want to consider the probability that in 30 years your employer will still exist, and if so, whether or not they will be doing well enough to satisfy all of their pension obligations. A lot can happen in 30 years. I’m not saying that it will, because obviously I don’t know anything about your employer, but just consider recent events: terrorist attacks, corporate scandals, etc.

    Case in point:

    Just yesterday a federal judge gave Delta Airlines permission to terminate its pilot’s pension plan. Delta is dumping their pension obligations for employees who have worked hard for perhaps decades and were expecting a decent pension (or at least what was promised to them when they signed the dotted line). Now they’re getting a nasty surprise. It still must go to the Pension Benefit Guaranty Corp. (a government agency that will make continued pension payments to the employee), but this is a REDUCED benefit (I don’t have the exact figures off hand I’m afraid). So the employees lose out. That promised money is gone.

    Furthermore, other airlines either already have, or are scrambling to dump their pension obligations on the PBGC as well: United, Northwest, etc. As the PBGC corp has to pay out more and more benefits (as a result of more corporations dumping their pensions), then the PBGC will be able to pay out less and less to each individual. Obviously not a pretty picture.

    So my point is, I don’t think the defined benefit plan is necessarily safe just because it “guarantees” a set amount in retirement. Who backs that guarantee? The company? What if the company goes bankrupt? (again with a long time horizon, anything is possible) I bet those Delta employees were guaranteed a set amount and now they’re probably not going to get it.

    If you go with the defined contribution plan, you are in control of your own financial success (or failure), and ultimately it is in your control and is your own responsibility. If ever given the choice, I will always choose a defined contribution plan over a defined benefit plan.

    Perhaps others will disagree with me but this is just my 2 cents. To give you some background on why I feel the way I do, my father just retired from Northwest Airlines last year after 26 years of work. Now there is real concern that Northwest (like many other airlines) is trying to dump their pension obligations. My parents are now having to consider the unpleasant possibility that they may be heading into retirement with considerably less retirement income than they had planned for.

  4. Anonymous

    Nickel — I’ll clarify. I wasn’t saying that your comparison is flawed, sorry if that’s what came across.

    I was reacting to your sentence: “I’ll just say that I have complete job stability, and I’m perfectly comfortable with the notion of remaining here through the vesting date (and beyond).”

    To me, a statement like that is begging life to prove you wrong. (e.g. “Nothing could possibly go wrong!” Cue thunderclap.)

    My comment was just a reaction to that (and a recommendation for the DCP).

  5. Anonymous

    You might also look into an Individual 401k or a Simple IRA. Both of these are good options for someone who also has self-employement income. You can contribute to both even if you have a plan with your employer. There is a cost for setting up the Individual 401K but the Simple IRA lets you set-up without any additional cost. (Note: the deadline for setting up a Simple IRA is October 1.) Most importantly, both allow you to contribute more than the SEP does, however, there are limitations if you are maxing-out your retirement plan at work. If not, then they are worth looking into….

  6. Beck, I’m not sure what your point is… Yes, my assumptions could be (and quite possibly are) flawed. But the only way to make an informed decision on something like this is to make a direct comparison between the plans. While my assumptions might (or might not) be incorrect in an absolute sense, they are close to equal between the two scenarios as possible. Thus, this should be a reasonably ‘fair’ comparison in a relative sense.

    If anything, I think that I have probably handicaped the DCP a bit by assuming 8% return and given the DBP a bit of a boost by assuming that all will go well with regard to vesting, etc. And yet the DCP still has the edge.

    I effectively judged the DCP conservatively and the DBP liberally, and the DCP still wins. So where’s the danger in making decisions based on this information?

  7. Anonymous

    You near anything wooden? You better knock it!

    Your post here is the equivilent of saying “Nothing could possibly go wrong!” Dude! You are making a lot of assumptions — all of which I hope come true, if and when, you (still) want them too, but — you’d be foolish to make big decisions like this based on them.

    I definitely vote for the contribution plan.

  8. Anonymous

    I agree. Even though it may seem like you’ll be there forever, ten years is a long, long time. (Don’t believe me? Think back to what you were doing 10 years ago and see how much has changed.) Even if your parents owned the company, you can’t be sure you’ll be employed in 10 years (just ask Bill Ford — who’s a step closer today to being “out”.)

    As such, I’d go with the defined contribution plan.

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