For Defined Contribution Plans

Current Pension Topics

For Defined Contribution Plans 

By JOEL L. FRANK

Q.: The Chief (Oct. 14 issue) ran a front-page article about the $35 billion accrued unfunded liability of the two major public-employee retirement systems in New Jersey, the Public Employees' Retirement System (PERS) and the Teachers' Pension and Annuity Fund (TPAF). How can this problem, which seems to always crop up during times of poor investment fund performance, be permanently solved?

S.T.

A.: Short of enacting a law that compels governments to make regular annual contributions to their Defined Benefit (DB) pension plans, public officials will always take a leave of absence during times of above-average investment returns and use what should properly be contributed to the plans for some other governmental expenditure. This is what happened in New Jersey and to a somewhat lesser degree New York and other states.

Of Note: This severe funding problem, however, never concerns a very small portion of the publicemployee work force in New Jersey, just like it doesn't concern the same group of employees in New York, or for that matter in all of the other 48 states. As you read this column, I. ask you to ask yourself the following question: If, in fact, the Defined Benefit (DB) approach is superior to the Defined Contribution (DC) type of plan, why don't the same unions that lobbied for the enabling DC. legislation back in the 1960s demand a dissolution of the Defined Contribution plans in favor of the Defined Benefit plan in which every other public employee must be enrolled?

The Defined Contribution Retirement Plan Should Be For All.

How would you like it if the State of New Jersey enacted legislation replacing your Defined Benefit (DB) type of retirement plan with an individual investment account that you own and control? The state, county or local governmental employer would contribute 8 percent of your salary to the investment while you would contribute 5 percent. Well, believe it or not, this type of retirement plan has been operational since July 1, 1969. Its existence is not widely known because only a select group of employees at the public institutions of higher education are eligible - "full-time faculty, officers, visiting professors, and certain professional administrative staff required to possess a college degree or its equivalent ..."

The plan is a Defined Contribution (DC) type of retirement plan under Section 403(b) of the Internal Revenue Code. While Section 403(b) plans, like Section 457(b), are more popularly utilized as a supplemental retirement plan funded solely by the employee, they may also be used as the mandatory retirement plan funded by both employer and employee contributions. In addition to contributing 5 percent to their mandatory 403(b) account DC. Plan participants may also make additional employee contributions on a voluntary salary reduction basis.

So, how has the DC Plan participant done over the past 37 years? Assume the following: Starting salary of $10,000, 13-percent contribution rate, 6-percent annual salary increment and a 9-percent investment return. Our hypothetical DC Plan participant has an investment account worth $709,000 today. The DB plan participant must annuitize his Pension Reserve balance (buy a fixed-income annuity from the DB plan), while the DC plan participant is not compelled to annuitize his $709,000 investment account balance. But in order to compare apples to apples, we must see how much of a fixed-income annuity or "pension" $709,000 could buy at various retirement ages. At age 55 the annuity would be $64,803; at age 60 the annuity would be $69,305; at age 65 it would be $75,537 and at age 70 it would be $84,392.

Our retiree from the PERS/TPAF has earned an annual lifetime Defined Benefit Pension calculated as follows: 1/55 x Years of Service x Final Average Salary, or 1/55 x 37 x $81,473 = $54,809 per year for life, irrespective of the member's age at retirement.

The test of time has proven the DC plan to be superior. After nearly four decades it should be made available to the nation's entire public-employee work force, not just to an elite few.

Mr. Frank is a fee-only Retirement Financial Planner. He can be reached by telephone at (732) 536-9472, by fax at (732) 536-7373, or via e-mail at rollover@optonline.net.