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Defined Benefit vs Defined Contributions

By Marti Zins TRA Representative on Retired Governing Board

Frequently people ask why it is important to maintain a pension plan for teachers and why worry if it is a defined benefit (DB) plan or a defined contribution (DC) plan. Let’s take the issue apart for understanding.

A defined benefit (DB) plan, also called a traditional pension plan, is a pooled retirement plan that offers a predictable monthly benefit in retirement. It provides retirees with an in-come for life, as you cannot outlive your assets. Typically both the employer and employee contribute, often in matching amounts. In Minnesota, that money is collected, pooled and invested on behalf of the educator by the State Board of Investments, resulting in a plan that generates 73 percent of the plan funding through investments. Investment fees are typical-ly low. The state sponsors the Minnesota DB plan.

A defined contribution (DC) plan has a monthly benefit from a DC or 401(k). A benefit is based on how much an employee contributes and earns through investment returns. The investment risk is wholly borne by the individual, as you, and only you, sponsor your DC plan. Some employers contribute, some don’t. Typically there are high investment fees and you might outlive your assets.

Money available to you as retirement income is figured using the “three-legged stool” - Social Security, personal savings and pension income.

The Wall Street Journal (2011) stated that a two-person household with pre-retirement in-come of $87,700 would need about $636,000 to meet their retirement needs. These house-holds have a median 401(k) balance of $149,000, less than one-quarter of what is needed
and an amount that would generate only $9,073 in annual income. This is not enough to achieve a secure retirement with sufficient income for our older years. The less money in the plan, the more you draw out, the smaller is your income each year. This is a DC plan.
Contrast this with the average monthly income from a DB plan (TRA) where the average ed-ucator has a pension income of $2,300 a month ($27,600 a year), and that income will come every month for life. Thus the importance of a defined benefit pension plan.

Much of this article comes, with permission, from MN TRA documents.


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