Defined benefit (DB) pensions are excessively expensive due to the advent of low cost broad market index funds.
With a DB pension, you have to add agency risk to the equation. There is no need for that now when you can get a Vanguard/Fidelity/Schwab 401k and pay the same 0.03% expense ratio to get the same investment performance that a pension fund manager would. And you never have to worry about the pension fund manager stealing from it, or the politician directing investments to their nephew’s real estate company.
I would rather have whatever normal cost the employer is contributing for DB pension given directly to me so I can drop it in VOO and cut out all the middlemen and reduce agency risk.
> The long-term cost of this is around 16-18% of payroll - 8-9% from my employer, 8-9% from me.
Assuming you work for the government in the US, this is false. Government entities in the US are allowed to use whatever nonsense assumptions they want to value liabilities, and obviously they undervalue them now and lay the extra cost on future taxpayers. Hence the underfunded DB pension and retiree healthcare crisis plaguing many taxpayers.
Finally, DB pensions and deferred benefits in general make it hard to compare compensation offers from different employers, which is also bad for workers trying to negotiate the highest price. Very few people are equipped to be able to properly price the value of a DB pension from one entity to another.
>With a DB pension, you have to add agency risk to the equation. There is no need for that now when you can get a Vanguard/Fidelity/Schwab 401k and pay the same 0.03% expense ratio to get the same investment performance that a pension fund manager would. And you never have to worry about the pension fund manager stealing from it, or the politician directing investments to their nephew’s real estate company.
>I would rather have whatever normal cost the employer is contributing for DB pension given directly to me so I can drop it in VOO and cut out all the middlemen and reduce agency risk.
It's a tradeoff. The risks you describe are real, on the other hand, no reason why the pension needs to be actively managed. It's certainly perfectly viable for the pension fund to be managed by plopping money into a few low cost vanguard funds, and the reason it doesn't work that way is probably partly inertia and partly job justification. But your individual investment has a big risk too - what happens when you turn 80 (90? 100?) and the money runs out? What happens if the market takes a shit the day before you turn 65? Time to start buying Alpo if you're not in a pension.
>Assuming you work for the government in the US, this is false. Government entities in the US are allowed to use whatever nonsense assumptions they want to value liabilities, and obviously they undervalue them now and lay the extra cost on future taxpayers. Hence the underfunded DB pension and retiree healthcare crisis plaguing many taxpayers.
You're confusing the pension fund liability with the actual long-term cost of the plan. The cost of the plan can indeed be gamed, but there's not much point. It's just an actuarial calculation with all the assumptions that entails, and the actuary shows that long term, investment of this amount is sufficient to cover all costs.
The liability is the part that can be gamed for political purposes - either maximized to spread fear/blame, or minimized to get a politician money to spend today. But importantly, the liability doesn't really have much to do with the long term cost of the plan, except to express that past funding has not been sufficient to cover all costs.
> But your individual investment has a big risk too - what happens when you turn 80 (90? 100?) and the money runs out? What happens if the market takes a shit the day before you turn 65? Time to start buying Alpo if you're not in a pension.
You can buy target date funds to minimize how much you have to manually reallocate between equities and bonds, and you can buy an annuity from an insurance company to guarantee a certain income.
I do not understand your distinctions between liability and cost of a DB pension.
> The cost of the plan can indeed be gamed, but there's not much point. It's just an actuarial calculation with all the assumptions that entails, and the actuary shows that long term, investment of this amount is sufficient to cover all costs.
There is a point…to contribute less than necessary for the pension plan to have sufficient funds, in order to make benefits appear cheaper today. For private company DB pension recipients, this results in them not being paid, hence strict laws like PPA 2006 and ERISA 1974. For taxpayer funded pensions, politicians just continuously increase taxes, so it is not as apparent of a problem.
For the DB pension recipient, they have the risk that the DB pension sponsor will come up short, either due to incompetence or corruption. That is a cost. Even taxpayer funded DB pension recipients have had their benefits cut when state and local governments could not come up with the cash.
Unless I had a federal government DB pension, I would assume there is nonzero risk of benefits being less than expected. Also, as a US resident, I have no doubt that even CPI adjusted benefits will be cut in real terms due to impending demographic issues and that is just how the game will be played. Feds will bail out equities over and over, and people with fixed incomes will continuously have less purchasing power.
Either way, I would rather own the assets being bailed out directly so that I can gain the most from the bail out, rather than pension fund gaining it and then still giving me a fixed benefit.
>You can buy target date funds to minimize how much you have to manually reallocate between equities and bonds, and you can buy an annuity from an insurance company to guarantee a certain income.
So to minimize the risk of market crash, you have to give up probably 4 or 5 years of decent returns by sitting in bonds instead. And if you want security of annuity you have to pay for that too, plus pay for the insurance man's profits. I just did a quote to put specific numbers in, to get 80k on my 100k salary for a set period of 20 years, I'd need to pay 1.1 million. That's 11 years of salary needed after taxes. Possibly I could have it after 32 years.
>I do not understand your distinctions between liability and cost of a DB pension.
The pension fund is a big pot of money that's supposed to have enough in it to pay costs for the next 30 years, assuming that the pension closed to new hires today. So the actuary says the present value of those costs is 10 billion, maybe the fund has 9 billion, you have a 1 billion dollar liability. This can be gamed.
But the actual costs for the next 30 years, based on actuarial assumptions and existing retirees, maybe are 18 billion in nominal dollars. Again, making assumptions about payroll, we can calculate this 18 billion as a percent of payroll over the same time. In my case, 16-18% is enough to cover. Unrelated to the fact that the fund has 9 billion or 11 billion or 1 billion.
> And if you want security of annuity you have to pay for that too, plus pay for the insurance man's profits. I just did a quote to put specific numbers in, to get 80k on my 100k salary for a set period of 20 years, I'd need to pay 1.1 million. That's 11 years of salary needed after taxes. Possibly I could have it after 32 years.
The insurance company selling annuities and defined benefit pension plan sponsor selling annuities are doing the same thing. Although, based on history, the insurance company is subject to better regulation. Insurance company profit margins are ~5% at most, and I am sure DB pension plan management gets paid just the same. And it is all getting invested into the same equities and bonds.
The only difference is if you are a recipient of a taxpayer funded DB pension, then your DB plan sponsor has the power to increase taxes and will be more likely to stick around longer than a private company.
The reason that non taxpayer funded employers moved away from defined benefit pensions is because proper accounting made them too expensive. The old days of counting on explosive inherent growth due to everyone have 3+ kids is over.
The taxpayer funded DB pensions stick around because it remains politically possible to keep kicking the can to future taxpayers. The fact that the rules around taxpayer funded DB pensions are basically non existent and non taxpayer funded DB pensions are strict is all that needs to be said. Why would the same liabilities be allowed to be accounted for in different ways?
> So the actuary says the present value of those costs is 10 billion, maybe the fund has 9 billion, you have a 1 billion dollar liability. This can be gamed. But the actual costs for the next 30 years, based on actuarial assumptions and existing retirees, maybe are 18 billion in nominal dollars.
How can an actuary say present value of liabilities is $10B and also $18B?
With a DB pension, you have to add agency risk to the equation. There is no need for that now when you can get a Vanguard/Fidelity/Schwab 401k and pay the same 0.03% expense ratio to get the same investment performance that a pension fund manager would. And you never have to worry about the pension fund manager stealing from it, or the politician directing investments to their nephew’s real estate company.
I would rather have whatever normal cost the employer is contributing for DB pension given directly to me so I can drop it in VOO and cut out all the middlemen and reduce agency risk.
> The long-term cost of this is around 16-18% of payroll - 8-9% from my employer, 8-9% from me.
Assuming you work for the government in the US, this is false. Government entities in the US are allowed to use whatever nonsense assumptions they want to value liabilities, and obviously they undervalue them now and lay the extra cost on future taxpayers. Hence the underfunded DB pension and retiree healthcare crisis plaguing many taxpayers.
Finally, DB pensions and deferred benefits in general make it hard to compare compensation offers from different employers, which is also bad for workers trying to negotiate the highest price. Very few people are equipped to be able to properly price the value of a DB pension from one entity to another.