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Benefit Analysis - Same Cost, Lower Investment Return

"That shouldn't be a problem," she pitched in. "I know if employees can choose their investments, the returns will be better than we get from a conservative pension plan." The smile dropped from my face faster than you can say Actuarial Present Value of Projected Plan Benefits.

I tried to be calm. "Actually, investment returns in employee-directed defined contribution plans are not traditionally as good as returns achieved by defined benefit plans. This happens for a couple of reasons. First, individual employees do not get the investment education that retirement board trustees go through. Second, individuals traditionally have a shorter investment time horizon. This leads to more conservative investing than you get from public sector retirement boards."

"So, tell me what happens to retirement benefits if my employees get a lower return." She was looking like a basset hound with insomnia. "If we lower the assumed rate of return on the defined contribution plan to 7%, and assume that the defined benefit plan is still able to get a return of 8% per year, our table changes to this:"

"It looks even worse," she said. "So you're telling me that a defined benefit plan is better than a defined contribution plan."

"No, actuaries don't use terms like better." Just the facts, I thought to myself. "There are good reasons to have a defined contribution plan, and there are good reasons to have a defined benefit plan. Sometimes, there are even good reasons to have both plans. What I am saying is that, for the same dollar contribution, an employee usually gets bigger retirement benefits from a defined benefit plan. If your sole objective is to save money, don't switch to a defined contribution plan. If you have other reasons, a defined contribution plan might be the answer."

Just then, the phone rings. "That was my secretary," my client says as she gets up. "My boss just died. We'll have to get into a discussion of reasons for each type of plan later."

"Sorry about the news," I say as I walk out the door. "At least its an actuarial gain to the retirement plan." Being an actuary is not just a job…