Defined-benefit plans continue to lose popularity

Those working for the departments are worried about whether the 52 percent level at which the plan is currently funded will be improved and who will pay for it.

The Springfield City Council May 15 voted to reduce benefits to new department hires, in an attempt to keep the pension plan solvent – much to the chagrin of the Police and Fire employees, who worry about the effects on morale and employee retention.

If this situation sounds familiar, it’s probably because it’s been heard before – with General Motors, United Airlines, the United Auto Workers and numerous other large corporations across the country.

The issue for local Police and Fire pension officials is the same one facing those larger groups. Corporations and governments are having trouble funding defined-benefit pension plans.

The defined-benefit pension model has been used in American companies for more than 100 years, according to Pension Consultants Inc. President Brian Allen.

The federal government came into the picture in 1974, passing the Employee Retirement Income Security Act.

That law, in addition to creating new regulations for defined-benefit plans, also created the groundwork for defined contribution plans, though Allen said those plans did not really become popular until the early 1980s.

‘Race to the bottom’

The major difference between defined benefits and defined contributions, as the name would suggest, is determining which side of the pension equation is constant – payouts or contributions.

“Defined benefit means that we don’t know how much we’re going to have to put in, but we know how much the employee is going to take out. The benefit is defined,” Allen said. “With defined contributions, we don’t know how much you’re going to get out, but we know how much is going to be put in.”

The flexibility of a defined-benefit plan for the employer is a strength when the economy is strong; investments yield high returns, thus reducing the amount the employer needs to contribute to adequately fund the plan.

The problem comes when a weaker economy creates lower investment returns, sticking the employer with the responsibility of coming up with the money.

Add to that the events of Sept. 11, 2001, and a rapidly aging work force – along with the largest group of retirees in the last century – and the result is a perfect storm, according to analysts.

Springfield City Councilman Bob Jones refers to the situation as the “race to the bottom.”

“The biggest fear I have is that the message we’re sending to our new hires, and to our current Police and Fire employees, is that we don’t care as much about them as we did,” Jones said at the May 15 council meeting. “I think that’s a terrible message, and I wish we weren’t part of that race to the bottom.”

‘Dinosaurs’

The problems with defined-benefit plans are quickly making them obsolete, Pension Consultants’ Allen said.

“Defined-benefit plans in general are becoming dinosaurs very quickly,” he said. “There are virtually no new defined-benefit plans being started, and the number of defined-benefit plans being terminated or frozen is growing all the time. Defined-contribution plans, including 401(k)s, are by far the most popular type of plan.”

Defined-contribution plans – 401(k) plans; 403(b) plans for schools, churches, hospitals and charities; and individual retirement accounts, both employer- and employee-funded – can also offer advantages to the employee, Allen added, due to the employees’ increased control over their investments.

The result: Companies are either changing to defined-contribution plans or, in cases such as the city’s Police and Fire pension, forced to make unwanted reductions.

“We’ve been willing to defer raises … so they have a more liberal retirement package,” Councilman Gary Deaver said at the meeting. “We’ve been backwards in how we made decisions. It doesn’t cost us much up front, but it’s time to pay the piper now, and that’s one reason we have this problem.”

Defined benefits vs. defined contributions

A defined-benefit plan:

• is totally employer funded

• has set payouts for employees

• has varied levels of contribution by the employer, based on payout needs

A defined-contribution plan:

• can be funded by the employer, employee or both

• has variable payouts for employees

• has a set contribution level