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Retirement Options

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Let’s talk retirement.

Until just this past year, hubs and I had saved absolutely nothing toward retirement. And, even this past year, we had just started saving $100/month (only in the months where we had an extra $100 to spare). In April we opened our very first Roth IRA for 2014 with a whopping $1,000 investment. That’s it. That’s our full retirement.

I’ve had in the back of my mind that I would start more aggressive retirement contributions after we’re completely consumer debt-free (the only thing left is the car!). But now that I’ve landed a full time job things are shaking up a little.

One maybe odd thing about this job is that they require mandatory retirement contributions. I’ve never heard of that before (but this is my first full-time job, so maybe it’s more common than I think???). Also, there are two separate retirement options. At first I mistakenly thought I could switch between the two, but that was inaccurate. After reading more (and speaking with HR), I’ve learned that once I select a plan – that’s it. There’s no changing the plan. Ever. For the entire duration of my career at the university, I am locked into the retirement plan (note: I can still change investments within the plan, see more below).

The big difference is that one plan is a defined benefit plan, whereas the other is a defined contribution plan. The defined benefit plan has a higher mandatory contribution and match (currently 11.48%, compared to 7% for the defined contribution plan), but it scares me that someone else is entirely in control of the investment. Plus, the defined benefit plan pay-out isn’t based solely on the amount contributed (like the defined contribution plan), it’s based on years of service, average monthly salary, and an actuarial formula.

In contrast, the defined contribution plan benefits are based solely on the amount I’ve contributed and how the investment performs across time. It allows me to select the investment company and investment allocations myself. So even though the match is a smaller percentage, I may be able to make it up with interest and growth across time (and benefit pay-outs aren’t contingent upon years of service, average salary, etc.).

There are lots of other factors to consider as well (e.g., the defined benefit plan offers health care subsidies after retirement and better long-term disability than the defined contribution plan). It kind of sounds, to me, like the defined benefit plan is similar to a pension….only it’s not free money from the employer. It’s money that has been paid-in by the employee (and matched by employer) all throughout the employee’s career. When I googled “defined benefit versus defined contribution” everyone says to participate in the defined benefit plan, at a minimum, and to add the defined contribution plan if possible, too. But I think this is different because the websites I looked at were assuming that the defined benefit plan was paid in full by the employer (not by employee contributions). Also, at my job it is not possible to participate in both. It’s an either/or (and no moving between them).

I’m leaning toward the defined contribution plan simply because the peace of mind of being in control of MY money instead of relying on someone else to be in control (also, I don’t like that the percentage of contributions in the defined benefit plan varies and that vesting doesn’t apply until termination of employment).

Reader thoughts or opinions? For anyone who would like to see the fine print, I’ve attached a retirement comparison chart I received. Thanks!!!

Retirement_ComparisonAug_2014

If you had the option, would you select a defined benefit plan (similar to a pension, but with mandatory employee contributions) or a defined contribution plan (just like a regular 401(k), with a 7% company match)? Why?


38 Comments

  • Reply SAK |

    so it isn’t unusual that you can’t switch – but many companies thath ave defined benefit plans have a dc plan that only the employee contributes to. i work on defined benefit plans (usually in distress) – so a couple of things. Very likely your contribution will go up over time and that some of the extra benefits will go away. (It is probably that they are splitting the cost of the plan 50/50 between employee and employer – whencost goes up so does your required contribution.) Especially given how far you are from retirement. Also, do you plan at being at this place for the rest of your career? DB plans get more valulable in terms of benefits the longer you stay. My quick recommendation is the DC plan – portability is great. But be careful with investments (dont be too conservative) and you should contribute as mush as possible – i’d suggest contributing the 11% you would have had to contribute to the DB plan even though it isnt all matched.

    Happy to go into much more detail if you like. A defined benefit plan can provide a far superior retirement – if all the stars align. But thay is getting harder.

    • Reply Ashley |

      Thank you so much for the info! I hate to even make a guess as to how long I’ll stay at the university. But as my first full-time job, I think the statistical odds are against me being there through retirement age. Who knows – crazier things have happened!

  • Reply Juhli |

    I believe you can still do a Roth IRA while in a defined benefit plan. My husband has federal defined benefit, Social Security and we did Roths for years for him too. The trick is that he will have spent 20 years working for the federal government when he retires so his “pension” is a good deal although not like military pensions. We need all 3 legs of this retirement stool (pension, social security and savings (Roths, rolled over retirement plans from other jobs, plain savings) for what we are expecting to be a financially sound retirement even if we live to 100. Think in terms of living a long time and make your decision that way.

    • Reply Ashley |

      Yes, I think we’d still be able to contribute to a Roth IRA outside of the university plans (I’d likely just keep contributing to the same plan I opened independently back in April). You’re right that, in the end, we’ll likely have multiple retirement vehicles (like the defined contribution plan I wrote about here, a Roth, and who knows what else?)

  • Reply Deeanna |

    Similar to SAK’s comment above, check out portability. Also, consider how long you need to be in place to earn benefits.

    In a similar situation previously and selected portability not thinking we would live in state (requirement) to benefit from defined benefit type plan. Looking back, It would have been nice because I could have essentially retired early and started another career having started so young. I did contribute to a Roth at the same time. However, the plan I did choose goes where I go and I control it, good bad or otherwise.

    As SAK stated, defined benefit can be nice is the stars align.

    Feel free to e-mail me questions.

    • Reply Ashley |

      I’d be eligible for benefits after 6 months, but I’m sure they’d be very low at that point (since they take into consideration number of years with the employer, etc.). I’ll check into the portability.

  • Reply Adam |

    I’m no expert but I’ll tell you I’d give my left kidney for a defined benefit plan at any job. Normally I’d sing the praises of index funds from Vanguard and doing defined contribution. But studies show that 401k’s have not been successful as far as providing for comfortable retirement. People don’t contribute enough, or they raid them for housing down payments, or stop contributing when things get tight – then combined with the fees, you end up with not enough at the end of 30 years,

    You are way way behind on retirement savings. If you see yourself staying in this university’s employ for many years, the defined benefit plan offers you a reasonable way out of the deep hole you’re in for not having any retirement savings so far. That plan, combined with Social Security, should provide enough income to “get by” in retirement.

    > “it scares me that someone else is entirely in control of the investment”

    Do you think you’ll do a better job?

    • Reply Ashley |

      Good point, I guess I don’t know how I’d do. But I like the fact that I could look at the available options (and their track records across time) to select investments that seem wise. I have no idea how they select investment for the DB plan. My guess is its a pretty conservative investment strategy (lower risk, but lower potential reward). Ugh! I wish there was a clear-cut answer!

      • Reply Nsheils |

        It doesn’t matter what investments they select. The payout is based on the formula you mentioned, which is years of service, your salary, etc. So whether their investments are low risk, high risk, etc they have to pay you out the amount that was defined in the plan. That’s why it’s a defined benefit, it’s not a maybe benefit that you might get if things go well.

        While the entire university could go under and then you’re in trouble, i’m hoping it’s a school with a good reputation and you see them lasting into the future. If their plan does get into trouble, generally they move the post for people coming into the pool later, so later retirement age when you can collect, longer avg salary, ie top 6 years of salary, not top 4 years.

  • Reply Adam |

    OK, I did a couple quick calculations. First, I looked at the DB website and it estimates that with 32 years of service, the DB plan would pay out 73% of your income monthly. That means if you make $3000/month today and get a 3% raise each year, then after 32 years of service, you’d get about $5800/month in income.

    If you use the DC plan, and make the same $3000/month now, get the same 3% raise each year, you save 7% of your income (+7% match for total of 14%), and you get a 7% average growth on your account for 32 years, you’ll end up with about $913k of retirement savings. Conventional wisdom says you can draw down 4% of that a year, which means you’d have an income of about $3100/month.

    These are very crude calculations with lots of assumptions – you really should talk to a financial advisor – which may be another benefit available through your new job. But my hunch is that defined contribution would be better if you were just starting your first job out of school at age 22-25. But since you are about a decade behind with no retirement savings, I have a feeling DB is going to be a better option for you.

    Whatever you choose, don’t let people’s gut reaction about which program is “better” guide your decision. Talk to a financial advisor and have them model out which one is specifically better for you given your specific circumstances. And on the DC plan, have them model out several scenarios for your investment options and returns over time so you get a sense of what the range of possibilities is.

    Also since you are behind I’d try to plan on putting some personal savings into an IRA from your new income before you have a bunch of other “needs” sneak in and take it.

    • Reply Juhli |

      That is a great analysis and actually assumes a higher rate of return than many people have been getting in defined contribution plans.

    • Reply Ashley |

      What about risk though? Not trying to argue, and I certainly appreciate you taking the time to run some crude numbers for me. But, as a few people mentioned, what happens if AZ legislature decides to snatch some pension money to cover budget deficits (AZ is a notoriously “poor” state – we rank toward the bottom with education, health care, etc.). Or if, as the costs of providing DB increase, they continue to jack the amount I’m contributing to cover other retirees, and then the program gets chopped so there’s no money left by the time I retire? I have no idea how likely (or unlikely) these types of scenarios may be. But I think the idea of just simply not being in control scares me. What if I’ve invested all this money across a huge chunk of time and end up with nothing on the other side? Probably unlikely, but crazier things have happened. I’m still thinking things over and plan to try to meet with a financial advisor about it within my first 30 days of employment, but playing a little devil’s advocate in the meantime.

      • Reply Adam |

        I’m from the Midwest and I can tell you that there is almost 0 risk of this happening. City of Detroit just went through one of the nastiest bankruptcies a public entity has ever gone through. Their government has been completely corrupt and several people have been put in jail over it. Fraud, abuse, mismanagement galore. Average response time for a 911 call was an hour. Over half the city’s streetlights were burned out. City almost had to auction off its public art collection if a few private individuals hadn’t made a last minute contribution.

        Even with all that, the bankruptcy settlement they eventually reached only reduced pension checks by about 4.5%. And something like that is basically unprecedented. Arizona isn’t even close to Detroit. There are a gazillion measures they will take before reducing the pension payment. Adjust the retirement age, adjust the actuarial calculation, raise taxes, raise contribution on younger workers, raid money from other departments – all of this will happen before they will reduce your payout. There is almost 0 risk. arizona is a conservative state, which means they are more likely to manage their budget and not go bankrupt and raid your pension fund. It will be fine.

        There is a much much bigger risk of you leaving or changing jobs and losing your university-vested contributions than there is a risk of the pension plan going belly up.

        I did some more calculations because I couldn’t resist, and I determined you’d need to average a 7.5% return over 33 years on your DC plan to beat the pension plan if you use the 4% drawdown rate during retirement. If you use a more conservative 2% drawdown rate, then you need to get an average of 10.7% return on the DC plan.

        But here’s the good news. On either plan, if you can put away 10-12% of your salary until retirement, you still have enough time to build up a decent nest egg to retire on.

        • Reply Ashley |

          You are seriously awesome!!! I love the “I did some more calculations because I couldn’t resist.” Made me smile! A true math nerd (math nerds, unite!)
          One of the courses I’ll be teaching this Fall is a stats class. I’m trying to figure out some good jokes I can squeeze into class. Real gems like, “I’ve never MET A ANALYSIS (like meta-analysis) I didn’t like!” (insert image of 200+ person class with blank stares and crickets, and me slapping my own knee laughing at my humor). Send any other good math/stats/numbers jokes my way! ; )

  • Reply Mrs. H. |

    I am a teacher, and have a defined benefit plan. I hate to burst your bubble, but we have mandatory contributions too, and participation in the plan is not optional. This is typical as far as I can tell. Many people believe that we “overpaid” teachers get some amazing pension, but it’s really not true. It may have been at one point, but no longer.

    That being said, there is something comforting knowing that I will have some money guaranteed in my retirement until the day I die.

    I am able to contribute to a 403(b) in addition to the defined benefit plan and I always have. The defined benefit is not going to be nearly enough to provide a comfortable retirement.

    I guess If I were in your shoes I’d take the defined benefit, but continue to fund retirement in other ways as well (IRAs, rental properties, taxable accounts etc…)

    Congratulations on the new job and all of the wonderful benefits that come along with it!

  • Reply Alice |

    “a pension….only it’s not free money from the employer”

    I had to comment on this, as a daughter of a public worker who’s pension is under attack. No pension is free money from the employer. People bargain for these things, often giving up other salaries and sometimes even access to social security to get them. Not to mention the decades of work people put in to get them. No one is getting a free lunch.

    Pension simply means ‘a regular payment made during a person’s retirement from an investment fund to which that person or their employer has contributed during their working life’ – BOTH of the options you’re choosing between are pensions.

    • Reply Jen From Boston |

      Exactly! You’re giving something to the pension, it’s just a question of how transparent it is.

  • Reply Jill |

    This is similar to what I have at my job, which is a faculty member at a mid-sized university. I went with DPC plan, mainly because you had to work in the state to be vetted in the DBC plan and it was not movable outside the state. Although I would like to think I am going to stay at my university for the majority of my career, life happens and I wanted options. From what I have heard from other friends in academia the options are similar across the country.

  • Reply SAK |

    going to be a little technical here but the DB and DC aren’t the same at all. A defined benefit plan says you will get X dollars each month when you retire (or a lump sum) based on this formula of age, years worked and rate. Your cost appears to be 1/2 of whatever the actuary determines that cost to be – you don’t get to pick the investments at all. And when the fund loses money (because it will) – you will pay more into it (and your employer will too) to make up some of the loss. Unfortunately very few DB plans invest conservatively – they are trying to make up for years of underfunding, retirees living longer and investment losses – they can’t afford a conservative portfolio. I agree a DB plan would be best in retirement but the current reality is that these are under attack in the public and private sector because of the increased costs. It is not a question of if they fail/shut down early/etc – but when – the cost is just too high (very sad but true). The odds of Ashley’s DB plan allowing her to accrue a benefit for the next 30 years is she stays that long are close to 0%.

    • Reply SAK |

      Forgot the DC part – defined contribution – the employer only says they will contribute x per year (either straight contribution or match or combo). You pick investments from allowed group, you decide how much to contribute up to the max. But you can roll it to an IRA if you change jobs. How much you take every month in retirement will be up to you based on account balance, other assets, tax rules, etc. – there is no guarantee on how much that is. Here to the employer can change what they contribute but that is less likely at public institutions.

  • Reply Stephanie |

    Other things to consider: What does your husband get if you die 2 months after you retire? nothing? 50%? 75%? While it may appear that the defined benefit gets you more money, you may have to forgo some of the benefit in order to purchase a survivor’s benefit for your spouse and children.

  • Reply Anon |

    How long do you think you will live? Barring an accident, I will likely live into my 100’s like most of my relatives. Given that, the defined benefit would be way better for me. If you have longevity in your family and will probably beat the average life span, take the defined benefit.

    What is Arizona’s track record with defined benefit plans? My husband works for North Dakota state and his pension is not behind at all but is fully funded. The state is so conservative here that they will never run out of money for their pensions. If the state was a broke one, I would totally go for a defined contribution plan. I would do a little research on the state’s track record.

    • Reply Ashley |

      That’s a great idea! I’ll have to check out the state’s track record. In relation to my life expectancy…not sure. We do have a lot of cancer in my family, but I was tested for 2 of the big ones (colon and uterine, both of which I’ve had grandparents experience) and I came back negative for the gene mutation. BUT, if I’m right about what I think my Dad has (he’s still undergoing testing to determine official diagnosis), it is genetic and tends to hit in the 50s. So that could dramatically cut my lifespan. Of course, I won’t know about his official diagnosis (and be able to be tested myself for the gene mutation) until after I have to officially select a plan. But its certainly something to think about.

  • Reply Joe |

    Either way, you’ll be saving more than you are now and that counts for something!

    I would personally go for DB if you think you see a long future at this institution. But I get the sense that at some point you may move for family reasons so DC might be better for flexibility.

    • Reply Ashley |

      With the direct contribution I can (just roll it over into an IRA). With the direct benefit plan it depends on the reason for the move. If an employee is terminated they’re only entitled to their portion (not the employer’s match), and I’m sure there’d be more red tape involved depending on reason for the move.

  • Reply stephanie |

    You really need to explore what will happen if you choose the defined benefit plan and then leave after 4 or 5 years. If I understand the attachment correctly, you only get to take with you YOUR contributions. But, I would ask other qualifying questions, like if you leave for another university in Arizona, do you remain under the same defined benefit plan?

    As for control over how money is invested, do you really want to take the time to learn about the different investment choices, watch the market, etc? Do you think you would do better than the investment analysts that run the defined benefit plan?

    It’s a hard decision to make but one you need to think out what is best in the long term. I’m kind of glad that I didn’t have to make a choice at my job. Good luck!

  • Reply Jen From Boston |

    In general, defined benefit plans, aka, pensions, are becoming less populer with employers because of the long-term liabiliy and fiduciary responsibility. Defined contributions plans, aka, 401(k)/403(b), are gaining in popularity as it shifts investment responsibility onto the employees.

    I know a lot more about DC plans than about DB, being in the private sector my entire career. I do have a small DB – my employer ended the program so whatever was in my “account” just stayed put, but it’s earning 5% interest each year. So by the time I retire it will be a nice little amount, but certainly not enough to live on.

    So, with that disclaimer, here are my thoughts:

    With the DC the plan it can go with you once you’re fully vested. You could even roll it over into a new employer’s DC plan, depending on the rules and such of the new plan. At the very least, you can roll it over into an IRA. And I believe your husband is automatically the beneficiary of the plan if something happens to you. I remember seeing something that if I were married and I designated someone other than my spouse as beneficiary then my spouse has to sign something saying it’s ok. But, that could just be a MA law.

    A DC isn’t as vulnerable to the whims of fund administrators or cash strapped governments, but it is vulnerable to YOUR decisions.

    Another thing to consider is additional retirement savings. As someone else mentioned, with a pension you can (probably) still contribute to an IRA. With the DC perhaps not, but that could depend on your AGI. If your AGI is below a certain level I think you can contribute to a traditional IRA and still be in a DC plan. You can also start a Roth IRA regardless of which plan you are in, I think. Of course, run this by a CPA/financial advisor 😉

    If you are in the DC plan you can also max out your contribution to the IRS limit. For 2015 I belive it’s $18,000. Obviously, since you’re starting mid year for you it’d be reasonable to be $9,000, if you can affford it. So you are not kept at 7% of your salary – you can increase the %.

    If you do go with the DC, you’ll have to pick the funds to invest in. If they have a target retirement fund that could be the easiest. It automatically re-allocates the assets based on how close you are to retirement. When you’re younger it’s more heavily invested in stocks. As you age it gradually switches to fixed income to preserve what you have. However, not all target funds are the same. Some companies will be more aggressive than others in the allocations.

    Another thing to look at are the underlying expenses for the funds. Expenses take away from the fund’s overall return. Index funds are lower cost – it doesn’t cost as much to program a computer to follow the market.

    • Reply Jen From Boston |

      I forgot to add… Assuming TPTB don’t abolish Medicare or raise the minimum age to something ridiculous, you’ll have health coverage through that, and may not need to rely as much on private insurance. Of course, it’s hard to know what the health care coverage situation will really be like 20-40 years from now.

  • Reply Theresa |

    My husband has a pension and when we recently discussed I mentioned that we didn’t have control and his point was the people managing the money are far more skilled at managing money than us. He works for a state government.

  • Reply AT |

    DC plans (the optional retirement plan) were put in place in many universities to be more attractive to faculty recruitment (only faculty and senior staff are eligible) because faculty tend to move across institutions and state lines in the course of their careers. The Arizona plan is relatively sucky (five years vesting, other states vest 100% immediately) but the DB plan is more like a plan for a public service employee who will work at the same instittution their entire lives).

    Be very careful. DH had to leave Texas to get out of the DB plan because he wasn’t paying attention and didn’t opt out in the first 30 days. When we moved to another state with better vesting (and the gold-standard TIAA-CREF plan, it looks the the AZ ORP is a poor knock-off of the TIAA-CREF program), he had more in his retirement in ten years than he had after almost 20 in the UT system.

    And would I trust the AZ legislature to not raid pension funds in a budget crisis over my lifetime? Hell no. Vesting matters. Don’t even consider the DB plan.

    • Reply Ashley |

      Thank you for this comment! Your last paragraph is one that scares me the most! Whose to say the money will – for sure – still be around when it’s time for me to retire? It feels a lot more comfortable to be in control of my own money, even if it means a potential for less money at retirement (that just means I need to up my own contributions). I like depending on myself instead of depending on others. Even if some see it as a super safe bet, I just don’t know how I feel about it.

      • Reply Adam |

        I commented above, but wanted to reply to this – just don’t be scared they are going to raid the pension. It could happen but many other things that affect this decision are much more likely to happen. It’s like saying “I don’t want to spend money on buying a car because it might get destroyed by a meteorite and insurance doesn’t cover space rocks.”

        I don’t know which is right for you – but I’d disagree with AT’s comment that you shouldn’t even consider the DB. You should consider both and make a reasoned decision.

        • Reply AT |

          Rolling Sone documented many legislative raids and attempts: http://www.rollingstone.com/politics/news/looting-the-pension-funds-20130926

          As I recall from 20+ years ago, The UT system was “directed” by the legislature to invest a portion of the DB funds in a scheme to start new tech businesses in the state. That to me is raiding and meddling in ways that I would not want my retirement funds invested in.

          Ashley, there’s a reason why they have a faculty plan and a separate plan for the hourly staff. When that opportunity to be Assistant Dean of Online Studies at some other university comes up, you don’t want to be choosing between leaving your money in their crappy investment program to keep the match or taking a new job in another state. DH walked from the UT match in their DB program, and made it up (mostly because of the more generous contributions at the new institution), but if he’d been in their ORP, it would have been much better financially.

          • Ashley |

            Thank you so, so much for all this info! On another note, how could you ever leave Austin? I mean, I know its getting too big and trafficky and all but…seriously. <3
            (can you tell my heart is in Austin???)

  • Reply Sluggy |

    Defined Bennie Plans have taken the place of the old employer funded Pension plans. I’d liken the DBPs to annuities more than anything else.
    Pros and cons on both DBPs and DCPS(401Ks).
    Hubs has both types of plans at his company.

    Eldest son just got his first teaching job in VA and the school district requires all employees to participate in the retirement plan. They are taking out 5% per year off the top of his pay. He groused about this to me but I said, “When you are old and decrepit like me and your dad you will THANK THEM! for making you save this money!” lolz

  • Reply Hp |

    I think your decision should probably come down to whether you think you will spend your entire career (or a substantial portion) in an institution that has this defined benefit system. When I started teaching (another state), I didn’t know if I would survive 30 years, so I did the defined contribution plan. I am now 10 years in and the defined benefit plan probably would’ve been fine even with our state legislature changing all of the parameters but there is still a large chance we will have to move for my husband’s job (goodbye my tenure 🙁 ). In that case, my DC plan will be a good choice.

So, what do you think ?