Defined benefits or defined contributions?

DALLAS Salisbury is chief executive of the Employee Benefit Research Institute, a Washington, D.C.-based think tank on employee benefits issues. He has been with the institute since its founding in 1978, and has witnessed the long decline in defined benefit plans. Salisbury warns, however, that the financial attractions of defined contribution plans are not as great as some company executives might think--even with recent legislation and accounting regulations that will require companies to fully fund their defined benefit pension plans.

Question: Aren't pensions on the road to being an endangered species?

Answer: Not necessarily. Any business has to start with deciding what it wants to achieve with a retirement benefit. If the objective relates to wanting to provide their employees with a retirement program at the lowest cost to the employer and provide adequate retirement income for the employee, nothing has changed because of the new federal legislation or the pending accounting changes to make a defined benefit plan any less attractive. A defined benefit plan will always be the cheapest way to provide that.

Q: Cheaper? How is that?

A: With a defined benefit plan, the employer can provide for the long-service employees who retire a very solid benefit for no more than 7 to 8 percent of income over time. Whereas to match that same benefit in a defined contribution plan, will generally cost an absolute minimum of 15 percent of pay.

Q: Why does it cost more to provide the same benefit with defined contribution plans?

A: No. 1, you're making that contribution for everyone. No. 2, you're making it up front. No. 3, people may leave, taking your money with them. So the employer is getting no benefit from 10, 20 30 years of investment earnings that was going into the program. When you look at it from the individual's perspective, as a practical matter, any employee who ends up being a short-term worker is going to be better off with defined contribution. Anyone who ends up staying at the same job for a long time is going to be better off with a defined benefit.

Q: So why then are companies abandoning defined benefit plans?

A: If the objective of the company is that they want the most predictable expense and they don't want any volatility, then a defined benefit plan is a very difficult thing--always has been. Because the amount of contributions they have to make is going to be volatile and not always predictable. You can't predict with certainty what the equity and bond markets are going to do.

Q: But what about the criticism that defined contribution plans don't leave employees with an adequate retirement?

A: If you add one caveat--that you do want people to have enough income to retire--then you've got to do a defined contribution plan where the employer contributes in the neighborhood of 15 percent of pay in addition to whatever amount the employee contributes.

Q: So, since we change jobs more often, aren't employees better off with a defined contribution plan?

A: Employers often use the excuse that they're switching to defined contribution because we now have a more mobile workforce, but it's really because their objectives for providing a retirement plan have changed. It used to be that the 10 percent of people who stayed until retirement were the ones the companies were trying to take care of. That's no longer their objective. But they don't want to say that.

Q: But don't we change jobs more often now?

A: It's a fallacy that we change jobs more often these days. When you look at labor three mobility statistics going back to 1951, the median job tenure has stayed between 3.8 and 4.1 years. It's just that that there were these certain industries--highly regulated or highly unionized industries such as phone companies and automakers--that had lower. turnover for many years.

Q: So then, what are employers' new objectives?

A: Because of the nature of technological change, employers are tar more worried about attracting and hiring the best people for a particular job at a particular point in time than in keeping them. Short-term workers have never placed value on defined benefit plans. They've always said, "Where's the money?" But when people cross the 20 years of service line at age 50, they wake up and say, "God, I'm not young anymore, maybe I'll want to retire some day--what are you guys going to do about that?" There's going to be a lot of baby boomers who will wish they had a defined benefit plan.

Deborah Crowe

Staff Reporter