This is a great example of the kinds of problems with "defined benefit" pensions compared to "defined contribution" plans.
Defined benefit plans rely on the firm to correctly manage their pension plan, allocate funds for it, invest them wisely etc. In public sector there is political pressure to reduce forecast costs of a defined benefit pension. In many places it's completely legal to operate an underfunded defined benefit plan. Defined benefit plans are also traditionally fixed to a single employer, they don't fit well for a more mobile labor force.
For defined contribution plans individuals actually have control of the pension funds - they are just locked from access til retirement. They are generally government run, you aren't locked to a single employer. Individuals can set their own risk appetite and make their own decisions regarding fees etc.
Defined benefit plans are really popular because the pension amount is "guaranteed" but this guarantee is just an illusion. You can't magically make risk go away, just move it somewhere else. Many examples of defined benefit plans that blew up/were restructured/cancelled etc. Defined benefit is just a plain bad concept.
Defined benefit plans work best when administered by an authority higher up the chain than a single employer. Like a union, trade organization, or government entity. Defined benefit plans work well when risk is spread, proper actuarial oversight is used, and especially for lower income jobs.
Defined contribution plans in the USA typically have an extremely small contribution by the employer. Works out great for the employer. Doesn’t work out so great for lower wage earners as they struggle to fund the plan.
> a union, trade organization, or government entity. Defined benefit plans work well when risk is spread, proper actuarial oversight is used
Note that all three of those are subject to democratic capture, in which low-information voters enable the pension managers to make poor risk and actuarial decisions. Of course, a defined-contribution plan is also subject to low-information control, but at least the damage is confined to the one making the mistake, not to those unwillingly along for the ride.
I understand that defined-contribution plans must offer similar terms to both executives and regular employees, specifically to help ensure that they are fair to employees.
You mentioned low-income workers twice, but I don’t see any inherent advantage to defined-benefit plans or inherent disadvantage of defined-contribution plans for them. It is arguable that low-income workers are also less educated and less likely to make wise or even reasonable investment decisions when in charge of their own funds. Of course, they are also less likely to make wise decisions in the choice of their pension managers.
Another huge advantage of defined-contribution funds is that one owns them and can pass them on to one’s heirs, unlike defined-benefit plans.
There is an advantage to defined-benefit plans which also come with insurance (e.g. disability), but I suspect it would be more efficient to unbundle them.
Whether the employer or the employee is contributing to a defined contribution or defined benefit plan, ultimately it's all coming out of the same "employee costs" bucket on the employer side.
Maybe they can work well with proper oversight, but the status quo for the majority of defined benefit plans is to be mismanaged and underfunded. See the role (union negotiated) defined benefit plans had in the US auto industry collapse. 60 out of the 100 largest corporate defined benefit plans in the US are underfunded, more than half! Chart in that article shows that 40% being funded is actually unusually high, historical trend is 15-20% of plans meeting funding levels. https://www.wsj.com/articles/companies-u-s-pension-plans-are...
Funding a defined benefit plan for lower wage workers vs paying lower wage workers more and contributing more to a defined contribution plan has exactly the same costs on the employer side. The only way the defined benefit plan appears to work out better for both parties is because we have legalized the employer not funding these plans to the appropriate level and hanging the supposed beneficiaries of the plan out to dry when it goes south.
Even ignoring the rampant underfunding issues defined benefit plans are a classic example of the principle agent problem where the interests/risk appetite of the fund manager and the fund members don't line up perfectly.
You have to have a good rules and governance. As you said, you need an upstream third party who is empowered to make awkward statements about contributions and such.
New York has a well funded pension plan because they have centralized control (it’s governed by a separately elected state official), there’s good governance around it and the law makes it difficult for local government to short their contributions.
Illinois and New Jersey took a more yolo approach and their funds are essentially insolvent.
I fail to see how that solves anything. You'll just wind up with the same mismanagement and "whoops, we're too big to fail, guess the taxpayers have to pay for it" that plague state government pension systems.
Does it? I think employers would be far better off if they didn't have to manage benefits. Having the employer administer everything was the deal we struck to provide socialist-like assurances for the middle classes while keeping the word "socialism" out of politics. The cost is every employer managing a complex system of benefits, workers navigating a bunch of different benefits systems as they change employers, more benefits systems to paper over gaps, and separate systems for a few categories of non-employed people that it would seem too brutal to leave unsupported. It's fantastically complicated, and there's no point to doing it that way except that we can call it capitalism.
Defined contribution is far worse, it's just a way to shift the risk onto the individual who is far less able to manage it, and then tell them it's their own fault they don't get a pension.
Defined benefit pensions work great outside of massive frauds. A better way to address that would be a government guarantee paired with prudential regulation and prosecution of frauds.
I’m not sure I agree but, yes, defined contribution does shift the onus of any savings onto the employee. The employer has basically washed their hands of it outside of possibly setting up a 401-k.
I’m not sure that’s inherently bad. Why should $CORP really be responsible for benefits 30 years hence? And, by the way, you probably need to work there for 10 years or so before the benefits even get interesting.
> Why should $CORP really be responsible for benefits 30 years hence?
Because they're in a better position to pool risk, hire expertise, and generally run a pension well than an individual is. I mean I do think governments should focus more on improving universal pension systems rather than offering tax breaks to get employers to do it for them, but pushing it right down to the individual is even worse.
They’re mostly just paying money into a pension fund someplace. (Though maybe not enough.)
An individual can farm out investments to a target date fund at Fidelity or wherever.
The argument/issue isn’t really that it’s hard for individuals to make investments relative to pensions but that many don’t. So we need to not make it an option and do it for them.
> An individual can farm out investments to a target date fund at Fidelity or wherever.
Sure, but they have no way of knowing that a target date fund is what they should be looking for, or which target date funds are good and which are high-fee scams (or rather, they have no way to know that high-fee is the thing to watch out for). The seemingly logical thing might be e.g. put everything in the fund with the biggest headline return number in the last year.
Defined benefit plans rely on the firm to correctly manage their pension plan, allocate funds for it, invest them wisely etc. In public sector there is political pressure to reduce forecast costs of a defined benefit pension. In many places it's completely legal to operate an underfunded defined benefit plan. Defined benefit plans are also traditionally fixed to a single employer, they don't fit well for a more mobile labor force.
For defined contribution plans individuals actually have control of the pension funds - they are just locked from access til retirement. They are generally government run, you aren't locked to a single employer. Individuals can set their own risk appetite and make their own decisions regarding fees etc.
Defined benefit plans are really popular because the pension amount is "guaranteed" but this guarantee is just an illusion. You can't magically make risk go away, just move it somewhere else. Many examples of defined benefit plans that blew up/were restructured/cancelled etc. Defined benefit is just a plain bad concept.