Did I Choose Wrong? Defined Benefit vs Defined Contribution

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enc0re
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Did I Choose Wrong? Defined Benefit vs Defined Contribution

Post by enc0re »

When I started my career at age 24 I was given a choice between a defined contribution plan and a defined benefit plan. At the time I was young and reflexively chose DC. That's because I wanted to be in charge of my investments and not be bundled with a big system. But now, 8 years later, I often wonder if I made the wrong choice. Perhaps there's no sense in crying over spilt milk. Nevertheless, I want to think this thing through one more time with the help of the Boglehead Collective.

It will hopefully help me put this issue to rest. If I made a mistake, this thread may help others from doing the same. Especially since I could point new hires towards it. Here are the plan details:

Defined Benefit:
1.5% x years of service x final salary (average of three highest years)
Increase by 3% thereafter, but not compounding. I.e. it increases by 3% of the initial amount.
Retire after 30 years or at 65.
(There's also a 90% co-pay for health insurance after retirement, but almost everyone expects that to disappear by the time I would retire.)
Cost: 7% of my paycheck.

Defined Contribution:
3.5% of my salary matched with 11.5% of my employer for a total of 15%.
TIAA-CREF.

Dear all, would you please help me hash this out one more time?
thewizzer
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by thewizzer »

WendyW
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by WendyW »

Partly depends how long you expect to live. If all of your grandparents lived to 90+, you probably made the wrong choice.

If you stay with one employer for your entire career, Defined Benefit is almost always a sweet deal.

In your case however, the DB plan seems maybe a little less-sweet than most (I think 2% of final salary is common?), and the DC plan seems kind-of unusually generous (your employer kicks in 11.5% of your salary?!).

I'm no expert on pensions though.
jaj2276
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by jaj2276 »

You probably won't know whether you made the right/wrong choice until much later in your life.

I, like you did, would have gone with the DC option when starting out. I didn't get an option and so was "forced" to take the DC plan. When my now wife got her job a few years ago, she too had an option similar to yours. Her choices were DB (.0182 x yrs_of_service x final_comp) after 28 yrs contributing 8% or DC with same contribution rate with a match of 5% of her salary.

Thinking back, I likely should have run some scenarios with my assumptions to see what the EV of each choice would have been and chosen the higher EV. However, since I was so heavily biased to the DC plans for my own investing, I simply told her to choose the DB plan (assuming correctly that we'd eventually get married).

All that said, I'm convinced that by the time she retires, her "benefits" as promised to her today won't be the same and the DC would have been the better choice. But C'est la vie.
Texas hold em71
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by Texas hold em71 »

Most people in your generation will not stay with the same employer from 24 to 65 making DC the better option for them.

Many employers eventually must tinker with both their DB plans and in the case of very rich DC plans such as yours, their DC match.

Some employers will freeze their DB plans sending the employees into the DC.

Some employers turn their DB plans over to the PBGC and the benefits are capped.

For those few who chose DB, don't change employers and whose employers do not do away with the DB, the DB very well may beat the DC but at 24, how do you know if that us you?

I think you chose well considering the odds.
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DonCamillo
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by DonCamillo »

You might not know whether you made the right choice during your lifetime. Things change.

I took a DC plan with my current government employer because I was hired under a rule that limited my job to a maximum of 7 years, and vesting in the DB plan took 10 years. If you left before that, you could apply to get your own contributions back with interest, but none of the state contributions. Then the rules that limited my job changed, and I now have 14 years. If I hit 20 years, which I currently expect to do, the DB plan has a very sweet kicker for veterans that might have made it much better for me. However, the state is having trouble funding its DB plans, and is requiring larger contributions and has stopped the COLA. So I may still be better off with the DC by the time I retire. Many private and some public DB plans have been severely curtailed in bankruptcy. With my DC, I was vested from my first contribution and my money is in a financial institution beyond state control. I contribute 5% of my salary and the state pays 8%.

The really big advantage with DC plans is that they are portable. Today the average person has seven employers. The ones who benefit with DB plans are the people who stay with one employer for a career. That is good for police and military, hard for most other careers.
Les vieillards aiment à donner de bons préceptes, pour se consoler de n'être plus en état de donner de mauvais exemples. | (François, duc de La Rochefoucauld, maxim 93)
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Watty
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by Watty »

Dear all, would you please help me hash this out one more time?
It will be hard to get an immediate annuity quote with the same inflation adjustment but a good place to start would be to see what an immediate annuity would cost you at the age you will retire at. If your defined contribution plan is likely to have accumulated that much then that would make them equal.

One of the unknowable things is what the interest rates will be when you retire and they are a major factor in calculating how much an annuity costs so interest rates are high when you retire then that would favor the defined contribution, if they are low then the pension would be favored.
dewey
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by dewey »

I think we should call them either a defined benefit or an undefined benefit since on the front end they are both essentially a defined contribution plan in the sense we have limited options as to whether to contribute or not, and how much.
“The only freedom that is of enduring importance is freedom of intelligence…” John Dewey
fposte
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by fposte »

I'm an Illinoisian in the DB plan, so this is a topic I mull over myself.

I think DB was a good choice for me at the time, because:
I would have managed the contributions horribly for the first fifteen or so years
I got in the older "Tier 1" tranche of employees in the DB system, which has a better deal and will be less vulnerable to future changes (the COL change will certainly bite if it really takes effect, though)
Illinois had a portable DB version, which I chose, so even if I move employers I'm still in a good position
I additionally have access to two good DC accounts, so I've been able to diversify

But I don't think I'd choose it now, and I think the younger you are, the more vulnerable you are to the changeability of just what definition is applying to those defined benefits. Illinois has one of the most legally protected pension systems in the country, but they're still going to find ways to diminish the pension because they have to. Heaven knows what's going to happen in Detroit.

Other things that will make a big difference are length of service/time of retirement and what you do with the funds when you retire. Our DC version will annuitize it for you, so you can end up essentially self-creating a pension anyway, or it'll do the usual rollover/lump sum options. Then, of course, there's the knowledge quotient.

So I agree that there's no way of knowing, but I think there's a good chance you picked the better course for you. And since you're here, it's pretty unlikely that you'd take any of the actions that would make it a markedly worse one.
beardsworth
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by beardsworth »

enc0re, your mention of TIAA-CREF as the adminstrator of the defined contribution plan indicates that you are in a university or research institution. You may take comfort in knowing that T-C is one of the best around and has some options you won't generally find elsewhere: the possibility of direct annuitization from CREF stock and bond accounts; the TIAA Real Estate Account which directly invests in commercial property; and the TIAA Traditional Annuity.

DonCamillo, above, has also raised the issue of vesting. Depending on your employer's rules, you may have had to wait--5 years? 10 years?--to be fully vested in a DB pension plan, meaning trouble if you left or were released before that time. With TIAA-CREF, you probably have owned the contracts since "day one" and--again subject to your employer's plan rules--were probably immediately vested in both your own contributions and the employer match.

Some people who work for entities of state governments and went with a traditional defined benefit pension are feeling nervous if their state is now on the lists of the many underfunded plans, as noted in the Chicago Tribune article linked by thewizzer above.

I agree with those here who say that you probably won't know the "right" answer to your question until later in life--and in any case, it's "water over the dam." Most people, including you, make the best decision they can at the time, based on the information at hand and the many future "forks in the road" which they can or cannot foresee. Don't beat yourself up about it.
rkhusky
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by rkhusky »

WendyW wrote: In your case however, the DB plan seems maybe a little less-sweet than most (I think 2% of final salary is common?), and the DC plan seems kind-of unusually generous (your employer kicks in 11.5% of your salary?!).
The federal government gives 1%/yr (1.1% if you retire at 62+ with 20 years or more), with the employee contributing about 7%, plus up to 5% match for the TSP.
tibbitts
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by tibbitts »

For me many years ago, the issue was vesting. If I recall the issue was vest in 13mo with TIAA or many years with the db pension. As it turned out I came within a whisker of surviving to the db vesting, but whiskers don't count in pension vesting, so it turned out much, much better for me to have taken TIAA. I'd never really considered not being able to keep that job "forever", right up until the end, but for whatever reason I chose TIAA anyway and it was by far the best for me as it turned out. A couple of more months and I might have regretted it, but you can't know those things ahead of time. It's just luck.
Topic Author
enc0re
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by enc0re »

beardsworth wrote:enc0re, your mention of TIAA-CREF as the adminstrator of the defined contribution plan indicates that you are in a university or research institution. You may take comfort in knowing that T-C is one of the best around and has some options you won't generally find elsewhere: the possibility of direct annuitization from CREF stock and bond accounts; the TIAA Real Estate Account which directly invests in commercial property; and the TIAA Traditional Annuity.

DonCamillo, above, has also raised the issue of vesting. Depending on your employer's rules, you may have had to wait--5 years? 10 years?--to be fully vested in a DB pension plan, meaning trouble if you left or were released before that time. With TIAA-CREF, you probably have owned the contracts since "day one" and--again subject to your employer's plan rules--were probably immediately vested in both your own contributions and the employer match.

Some people who work for entities of state governments and went with a traditional defined benefit pension are feeling nervous if their state is now on the lists of the many underfunded plans, as noted in the Chicago Tribune article linked by thewizzer above.

I agree with those here who say that you probably won't know the "right" answer to your question until later in life--and in any case, it's "water over the dam." Most people, including you, make the best decision they can at the time, based on the information at hand and the many future "forks in the road" which they can or cannot foresee. Don't beat yourself up about it.
Vesting period was 10 years and that's certainly a bit of a gamble. However, rationally I always thought the chance of me losing my job was fairly.

I intend to use TIAA-CREF as an immediate annuity upon retirement just as you suggest. In addition to the 15% from my DC plan, I'm also contributing the maximum to my 403(b) and 457(b) accounts which are with T-C. So I should be fine. It's really a neat system.
Topic Author
enc0re
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by enc0re »

rkhusky wrote:
WendyW wrote: In your case however, the DB plan seems maybe a little less-sweet than most (I think 2% of final salary is common?), and the DC plan seems kind-of unusually generous (your employer kicks in 11.5% of your salary?!).
The federal government gives 1%/yr (1.1% if you retire at 62+ with 20 years or more), with the employee contributing about 7%, plus up to 5% match for the TSP.
For the DB plan my employer has to contribute something like 24% of my salary. So contributing 11.5% is quite the savings for them and they use it to incentivize employees to choose DC.
Topic Author
enc0re
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Re: Did I Choose Wrong? Defined Benefit vs Defined Contribut

Post by enc0re »

While obviously the choice between DC and DB varies with your individual situation, I was wondering if there was a rule of thumb comparison? Something like: a 1.5% pension factor is equivalent to a 15% DC contribution; or something like that. What is the rough and tumble way people get a first impression how DB and DC plans compare?

BTW, thanks to everyone for the encouragement that I did the best I could. It was really intimidating to make such a lifelong irrevocable choice when being hired at age 24. Especially since I knew that ideally I would want to stay with this employer for the duration of my career.
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