5 ms·

Defined benefit plans are unaffordable, whether for a company or a government. But while defined contribution actually generate great returns, they have the pro

Defined benefit plans are unaffordable, whether for a company or a government. But while defined contribution actually generate great returns, they have the problem that urgent expenses always crowd out saving, particularly for lower income groups (same as it would if income taxes were collected annually, or less frequently). Seems like the optimal solution is to combine the compulsory contribution part of the current social security system with a defined contribution system that can actually generate the income that will be needed. As far as I can tell, the pension system in Chile in the 80’s and 90’s was like this, and had the additional benefit of generating large amounts of investment capital during its operation which helped economic growth. https://en.m.wikipedia.org/wiki/Pensions_in_Chile https://en.m.wikipedia.org/wiki/Pensions_in_Chile

ec109685 9y ago
Why are defined benefit plans always unaffordable? You don’t want people’s retirements to be affected by the value of their investment at the moment of withdrawal. Instead you want the benefit to incorporate the expected value at retirement of the investment over the long run. The problem with many pensions is that the businesses themselves supporting them essentially went belly up as competition, technology and investors took their toll.
- zzleeper 9y ago
  For company plans, you said the answer. It's silly to assume that your employer will be alive when you are 80 year sold, and also seems like a stupid idea for a company in a completely unrelated business to get into the retirement fund mgmt business. For states, the reason is population. If your pop doubles every 50 years, then you only need 2 young people to pay for one retiree. If it's the opposite (Japan now, US in a few decades), then you are screwed.
  - briandear 9y ago
    So it’s a Ponzi scheme.
    - toomuchtodo 9y ago
      Only if you have the unrealistic view that each generational cohort is completely isolated economically.
    - JetSpiegel 9y ago
      More like a loan from current workers to be repaid when those workers retire.
- jshaqaw 9y ago
  This is a good point. DC is no more “unaffordable” inherently. DC puts the volatility of upside and downside shocks on the individual (or more practically an age cohort) versus smoothing it out over wider age cohorts. For example, I have lots of savings. The market up 20% this year is great for me. Not so much for the next age cohort who face mathematically lower returns from this level. If anything DB at the margin forces more realistic upfront accounting (despite pension accounting flaws) because when an entire age cohort faces ruin they will vote to socialize much of the pain anyway ex post.
- wbillingsley 9y ago
  Some modern defined benefit schemes do that -- give a formula for the total dollar value you'll receive at retirement. And if you want to convert that to a pension you buy an annuity with it. However, they seem (to me) to have a couple of problems - - as the formula is often based on your last five years' average salary, it seems like an "all eggs in one basket" on your salary growing. Which seems to be the inverse of the sort of hedging and diversifying you try to do with personal investments -- if my salary grows I already gain, but I'd like my retirement savings to grow even if for any reason my salary stalls in 20 years' time. - the formulas seem to be quite fixed and can have some perverse incentives. For instance, "average salary from the last five years" seems (to me) to be partly behind why Vice Chancellor roles changed so much -- someone stepping back from being a VC to being a professor would face a salary drop, which would then affect their defined benefit pension calculation (costing them a lot of money), so it became "up or out" and the idea of university leadership roles as being a service role that academics would take on for a while simply died because it had to be the last role you took before retirement. Ok, that's a bit of an aside about how pension schemes can change the nature of the university, but practically speaking I'd like to keep the option of doing things like semi-retiring at the end of my career (dropping to part-time or doing something interesting that might not increase my salary) without incurring a massive penalty on my retirement savings.
ThrustVectoring 9y ago
There's a huge problem with defined contribution plans that isn't in defined benefit plans: the contributions belong to the retiree and get inherited by their children, rather than helping fund seniors as a class. Ideally you'd want some sort of tontine-like features, where people receive mortality credits based on their contributions and actuarial tables for their age. It'd mean that saving enough for retirement is much more economically feasible.
- nugget 9y ago
  If you annuitize your 401k balance at retirement you're effectively participating in a Tontine-like structure with fees paid to the insurance and reinsurance companies in return for administration and risk mitigation.
  - ThrustVectoring 9y ago
    Indexed annuities are crap, single premium inflation-indexed annuities are pretty much the ideal product but not enough people are buying it for it to be offered, and buying a flat single-premium immediate annuity has some execution problems with dealing with inflation properly. There's significant execution hurdles with this plan. And like, yeah, this solves the problem for me, but I'm already a high-income earner who is financially literate enough to reason through these things. Having it be opt-out or mandatory solves this for the people who aren't as lucky.
- walshemj 9y ago
  Not always until recently in the uk you could not pass on any of your pension to your kids and there are limits now ie only you die before 75.
walshemj 9y ago
Ah no it all depends on the accounting rules which have been fiddled by using unrealistic assumptions a lot of the DB deficits in the UK would not be as huge (and affordable) or actually be in profit if more realistic accounting rules where in place. Ask yourself who benefits when you see scare stories about pensions

ec109685 9y ago

Why are defined benefit plans always unaffordable? You don’t want people’s retirements to be affected by the value of their investment at the moment of withdrawal. Instead you want the benefit to incorporate the expected value at retirement of the investment over the long run. The problem with many pensions is that the businesses themselves supporting them essentially went belly up as competition, technology and investors took their toll.

zzleeper 9y ago
For company plans, you said the answer. It's silly to assume that your employer will be alive when you are 80 year sold, and also seems like a stupid idea for a company in a completely unrelated business to get into the retirement fund mgmt business. For states, the reason is population. If your pop doubles every 50 years, then you only need 2 young people to pay for one retiree. If it's the opposite (Japan now, US in a few decades), then you are screwed.
- briandear 9y ago
  So it’s a Ponzi scheme.
  - toomuchtodo 9y ago
    Only if you have the unrealistic view that each generational cohort is completely isolated economically.
  - JetSpiegel 9y ago
    More like a loan from current workers to be repaid when those workers retire.
jshaqaw 9y ago
This is a good point. DC is no more “unaffordable” inherently. DC puts the volatility of upside and downside shocks on the individual (or more practically an age cohort) versus smoothing it out over wider age cohorts. For example, I have lots of savings. The market up 20% this year is great for me. Not so much for the next age cohort who face mathematically lower returns from this level. If anything DB at the margin forces more realistic upfront accounting (despite pension accounting flaws) because when an entire age cohort faces ruin they will vote to socialize much of the pain anyway ex post.
wbillingsley 9y ago
Some modern defined benefit schemes do that -- give a formula for the total dollar value you'll receive at retirement. And if you want to convert that to a pension you buy an annuity with it. However, they seem (to me) to have a couple of problems - - as the formula is often based on your last five years' average salary, it seems like an "all eggs in one basket" on your salary growing. Which seems to be the inverse of the sort of hedging and diversifying you try to do with personal investments -- if my salary grows I already gain, but I'd like my retirement savings to grow even if for any reason my salary stalls in 20 years' time. - the formulas seem to be quite fixed and can have some perverse incentives. For instance, "average salary from the last five years" seems (to me) to be partly behind why Vice Chancellor roles changed so much -- someone stepping back from being a VC to being a professor would face a salary drop, which would then affect their defined benefit pension calculation (costing them a lot of money), so it became "up or out" and the idea of university leadership roles as being a service role that academics would take on for a while simply died because it had to be the last role you took before retirement. Ok, that's a bit of an aside about how pension schemes can change the nature of the university, but practically speaking I'd like to keep the option of doing things like semi-retiring at the end of my career (dropping to part-time or doing something interesting that might not increase my salary) without incurring a massive penalty on my retirement savings.

ThrustVectoring 9y ago

There's a huge problem with defined contribution plans that isn't in defined benefit plans: the contributions belong to the retiree and get inherited by their children, rather than helping fund seniors as a class. Ideally you'd want some sort of tontine-like features, where people receive mortality credits based on their contributions and actuarial tables for their age. It'd mean that saving enough for retirement is much more economically feasible.

nugget 9y ago
If you annuitize your 401k balance at retirement you're effectively participating in a Tontine-like structure with fees paid to the insurance and reinsurance companies in return for administration and risk mitigation.
- ThrustVectoring 9y ago
  Indexed annuities are crap, single premium inflation-indexed annuities are pretty much the ideal product but not enough people are buying it for it to be offered, and buying a flat single-premium immediate annuity has some execution problems with dealing with inflation properly. There's significant execution hurdles with this plan. And like, yeah, this solves the problem for me, but I'm already a high-income earner who is financially literate enough to reason through these things. Having it be opt-out or mandatory solves this for the people who aren't as lucky.
walshemj 9y ago
Not always until recently in the uk you could not pass on any of your pension to your kids and there are limits now ie only you die before 75.

walshemj 9y ago

Ah no it all depends on the accounting rules which have been fiddled by using unrealistic assumptions a lot of the DB deficits in the UK would not be as huge (and affordable) or actually be in profit if more realistic accounting rules where in place. Ask yourself who benefits when you see scare stories about pensions