Pensions Provide Benefits at Half the Cost of 401Ks

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Grt2bOutdoors
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Pensions Provide Benefits at Half the Cost of 401Ks

Post by Grt2bOutdoors »

Well, no surprise here.....it's all about the :moneybag :

New updated report put out today by the National Institute for Retirement Security: Pensions can Provide Benefits at About Half the Cost of Defined Contribution Accounts and 29 percent lower than an ideal Defined Contribution Plan

All those extra costs are robbing folks of money that could be sustaining them into old age.

Here's the report link: http://www.nirsonline.org/storage/nirs/ ... k_2014.pdf
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munemaker
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by munemaker »

The examples they give are government employees (teacher, firefighter).

We could all take more risks to achieve better performance if we had the government backstopping us.
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Grt2bOutdoors
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by Grt2bOutdoors »

munemaker wrote:The examples they give are government employees (teacher, firefighter).

We could all take more risks to achieve better performance if we had the government backstopping us.
I can't speak for them, but my thoughts are they used the government employees simply because the vast majority of defined benefit plans in existence are municipal and the multiplier rates used per year are representative of what that particular population (teacher, firefighter) are contractually guaranteed.

I don't disagree, however, a defined contribution plan has individual control instead of centralized control as found in a defined benefit plan leaving too much discretion at the hands of someone who is ill equipped. The government backstop would be immeasurable, the risks unlimited unless you capped the eligible investments to just a few standardized broad indexes and that would certainly make the investment industry quite upset.
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crake
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by crake »

I haven't read the whole paper, just the executive summary but it seems to have a significant amount of bias. The author, "William B. (Flick) Fornia is President of Pension Trustee Advisors, Inc., specializing in public sector retirement plans. "
1. A typical DB plan provides equivalent retirement benefits atabout half the cost of a DC plan, and 29 percent lower cost than an “ideal” DC plan modeled with generous assumptions.
I could be wrong but it appears like the authors are defining cost here as the total amount of contributions put into the plan, not as the fees deducted from the plan. I don't think this is inherently wrong but later on in the paper a number of invalid comparisons are then made.
2. DB plans have three structural cost advantages compared to DC plans: longevity risk pooling, the ability to maintain a well diversified portfolio over a long investment horizon, and low fees and professional management.
1. Longevity risk pooling can be obtained via annuitizing a portion of ones DC plan. Nowhere does this paper mention the negative affect annuitizing has on ones benefactors. The paper only mentions the positive effect of risk pooling without any of the negatives.

2. I believe the average pension plan maintains about a 60/40 Stock/Bond allocation. An individual investor could easily maintain the allocation for a lifetime if they wanted to.

3. Professional Management...If ones wants professional management they can get it with a DC plan. I for one am personally glad I don't have a professional managing my money.


I do not believe there are any free lunches out there. A pension fund can be invested poorly or it can invested excellently, the same can be said for DC plans. Any economies of scale arguments apply equally to both DB and DC plans. A small company will have as much trouble providing a cheap DB plan as they would have providing a cheap DC plan. My portfolio's overall expense ratio is .12%. A Pension fund would have a very tough beating that.
Last edited by crake on Thu Dec 04, 2014 9:08 am, edited 1 time in total.
adamthesmythe
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by adamthesmythe »

One of the cost-efficient aspects of a pension plan is...

not all employees become vested, because of resignations, layoffs, etc.

I agree there is additional overhead for individual accounts...but we know how to minimize that. I haven't run the numbers but I cannot imagine that this accounts for half the cost.
crake
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by crake »

One of the premises in the paper I can agree to is that the vast majority of investors are incapable of managing their own retirement. I used to work at a company that didn't have internet access. In 2011 a co-worker of mine expressed that this put us at a huge investing disadvantage because we couldn't "get out of the market when it was tanking." This same co-worker held about 50% of his portfolio in a former employees stock. What scares me about pensions is that someone with the same beliefs could be managing my money.

I don't know if there is a good answer to this conundrum. The current system works for me so I am happy, but I am willing to admit being a little selfish in that regard.
anonforthis
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by anonforthis »

Delete.
Last edited by anonforthis on Thu Dec 04, 2014 9:34 am, edited 1 time in total.
donaldfair71
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by donaldfair71 »

munemaker wrote:The examples they give are government employees (teacher, firefighter).

We could all take more risks to achieve better performance if we had the government backstopping us.
Not sure what is meant by "Backstopping". If contributing 7-15% of salary (depending on position/locality) to a db that might not be there someday is backstopping these days...
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tfb
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by tfb »

If cost is defined as the contributions required to arrive at the same retirement benefits, I don't believe pensions have a significant advantage, not to the scale of 50%. The money has to come from somewhere: heirs, employees not vested, ... If cost is defined as the admin cost, it's true 401k plans have a higher cost because they have to maintain individual accounts. However, that cost is already low enough in good plans. I can live with it. Cutting it further in half doesn't make much difference. The true costs as we all know are in investment management. Pension plans can hire expensive managers the same as 401k plans.
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sciencenerd
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by sciencenerd »

Didn't have time to read the full article but skimmed over it. It seems to be a very good analysis, with longevity risk pooling, in my view, being one of the most important benefits of the DB pension plans.

The data in the article also touch on a couple of points that are not discussed:

1) The savings rate for the DC plan needs to be in the range of 31% of annual salary. This means that most contributors probably vastly under-save. With company matches often no more than 4-6%, it is hard to imagine that annual savings rate of the average person is more than 10%, probably often much less.

2) The policy of 401k plans is often opt-in vs. opt-out. This means that employees often don't contribute, because they have to take the active step of opting in, which many don't take. Together with point 1, this leads to the woeful unpreparedness of today's average retiree for retirement, and their significant reliance on social security to fund retirement.

While I, personally, may benefit from the 401k/IRA DC system for my own retirement, due to my high savings rate, I am afraid that the large majority of retirees would be much better served by a traditional DC pensions system.
crake
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by crake »

sciencenerd wrote: 1) The savings rate for the DC plan needs to be in the range of 31% of annual salary. This means that most contributors probably vastly under-save. With company matches often no more than 4-6%, it is hard to imagine that annual savings rate of the average person is more than 10%, probably often much less.
The notion that you have to save/contribute more money in a DC plan than a DB plan for the same benefits is disingenuous. The only way this could be true is if DB plans had lower costs and/or greater returns. The money needs to come from somewhere. The reason why it seems like you need to save/contribute less in a DB plan is that people leave the company before vesting and people die before drawing down benefits. Those are both real costs for either the individual employee or the benefactors. There are also some subtle costs in a DB plan that take the form of being tied to a specific company/job. I take great pleasure In knowing that I don't have to be tied to to any specific job for 30+ years in order to retire comfortably.
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by ftobin »

crake wrote: The notion that you have to save/contribute more money in a DC plan than a DB plan for the same benefits is disingenuous. The only way this could be true is if DB plans had lower costs and/or greater returns. The money needs to come from somewhere. The reason why it seems like you need to save/contribute less in a DB plan is that people leave the company before vesting and people die before drawing down benefits.
Wouldn't a big reason that DC plans require more savings is that you have to over-insure against longevity? With DB plans, the longevity risk is pooled, so in aggregate everyone needs to just insure for the average lifespan.
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munemaker
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by munemaker »

donaldfair71 wrote:
munemaker wrote:The examples they give are government employees (teacher, firefighter).

We could all take more risks to achieve better performance if we had the government backstopping us.
Not sure what is meant by "Backstopping". If contributing 7-15% of salary (depending on position/locality) to a db that might not be there someday is backstopping these days...
Government backstopping means if the defined benefit plan does not have enough money to pay the promised amounts, the taxpayer steps in to make up the difference.
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by Barry Barnitz »

Hi:

The latest report on the underfunding of public defined benefit schemes----> Promises Made, Promises Broken 2014: Unfunded Liabilities Hit $4.7 Trillion > Publications > State Budget Solutions
State Budget Solutions' latest research reveals that state public pension plans are underfunded by $4.7 trillion, up from $4.1 trillion in 2013. Overall, the combined plans' funded status has dipped three percentage points to 36%. Split among all Americans, the unfunded liability is over $15,000 per person.
Each year, state public pension plans must disclose their funding progress, showing their assets and liabilities, and providing information as to how the plans intend to pay for the pensions of millions of government employees. One quick glance at any given plan shows that there are several problems with the current system.

First, state pension funds use a high discount rate. Discounting liabilities is a necessary part of fund management. Fund managers must assume that the current assets will be worth more in the future due to a number of factors, notably the return on investing those current assets. The problem arises because the discount rate is not based on the nature of the assets held by the pension plan, but is rather based on the assumed rate of return.

A recent report from Moody's Investor Services explains that even though the 25 largest state pension plans have been very close to meeting those lofty investment return goals in the last 10 years, their unfunded liabilities are nearly $2 trillion.

Second, state governments are often guilty of exacerbating the high discount rate problem by not making the necessary annual contributions to the pension funds. State Budget Solutions found that in recent years several states have reduced the annual required contribution to the pension funds, or just skipped the payment altogether.
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by OutInThirteen »

crake wrote:There are also some subtle costs in a DB plan that take the form of being tied to a specific company/job. I take great pleasure In knowing that I don't have to be tied to to any specific job for 30+ years in order to retire comfortably.
It is possible, although somewhat rare, to work for an employer large enough to be able to hold many different jobs over a long career. In my case, I worked for a large university system with several federal government contracts and was able to work in a dozen distinct professional jobs over a term of 22 years. I'm not so sure if those kinds of opportunities exist in the private sector.
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by crake »

ftobin wrote:
crake wrote: The notion that you have to save/contribute more money in a DC plan than a DB plan for the same benefits is disingenuous. The only way this could be true is if DB plans had lower costs and/or greater returns. The money needs to come from somewhere. The reason why it seems like you need to save/contribute less in a DB plan is that people leave the company before vesting and people die before drawing down benefits.
Wouldn't a big reason that DC plans require more savings is that you have to over-insure against longevity? With DB plans, the longevity risk is pooled, so in aggregate everyone needs to just insure for the average lifespan.
What that analysis is missing is that some people would like to leave money to their heirs or charity after they pass rather than to their former co-workers. If someone wants to make that choice who doesn't have a pension they can always annuitize their savings.

Insurance doesn't come free but the authors of the paper would like to make you think that it does.
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Re: Pensions Provide Benefits at Half the Cost of 401Ks

Post by ruralavalon »

DC worked well for me, with my money being portable when changing employers. I never had a "good" plan or an employer match. DC with its portability is the better solution for most private sector employees.

Most people switch jobs quite often, the median job tenure is 5.2 years, and because of vesting rules and accrual formulas either never quality for the employer's DB plan or wind qualifying for only a small pension benefit. Fewer than 1 in 5 private sector employees ever work for a single employer as long as 25 years.

For a short discussion, Google "EBRI The Good Old Days."
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