Allocation of Benefits
"This is more than just a question of risk and
reward," says the client. She
goes for her right bottom desk drawer, and reaches in. I move back, getting
ready for anything. Turning toward me, she whips out a magazine article.
"The money isn't getting to my employees. It says here that 70% of state
workers in California lose their retirement benefits because they leave their
job before qualifying for them."
Quickly, I go to my bag. In a second, my PC is out,
fully loaded. "You want numbers?" I said, "let's talk
"A second key difference between your
traditional defined benefit and defined contribution plans is how benefits are
allocated. A defined benefit plan allocates more money to your longer service
employees. Even though 70% of your employees leave without receiving a
retirement benefit, over 90% of your plan assets go to retirement and disability
benefits. Remember, these are retirement plans. They are designed to attract and
retain good employees by rewarding long careers."
She looked stunned, but I had to keep going.
"In a defined contribution plan, the participants still get the money, they
just get different amounts. A defined contribution plan gives more money to
employees who work only a short time for your agency."
"So," she responds, "more employees
will get some of the employer's money from a defined contribution plan."
"No, that's not completely correct." I
tried to sound as diplomatic as an actuary can. "In both traditional
defined benefit and defined contribution plans, employees receive employer money
only after they are vested. In your particular defined benefit plan, it takes 5
years to get vested. If an employee leaves before he's worked for 5 years, he
only gets back his own contributions with interest. Almost half of your
employees leave before they reach five years of service. Any employee who works
for five or more years will be able to get some benefit from employer
contributions. A traditional defined contribution plan also has a vesting period
for employer contributions."
"So, in a defined contribution plan, an
employee will get her money back if she leaves before working for five
years." She was starting to understand.
"And she will get some of our money if she stays five years or more.
I understand now that the same people get the money. I don't understand how they
get different amounts."