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