A defined benefit plan is a pension plan that pays out a defined amount based upon a formula. One cannot outlive the benefit. In addition, the benefit does not change or drop when stock markets falter.
In the Teachers Retirement System (TRS), the current formula is defined as 2.2 percent times final average salary times years of creditable service.
In a defined contribution plan, like a 401(k), 403 (b), or 457 plan, only contributions are defined. The member’s benefit is not. The pension plan is determined by how well the member invests the account and market conditions at retirement. Unfortunately for some, earnings may fall short, or the member may outlive the defined contribution account.
Defined Contribution Will Not Save Money
A few states have adopted defined contribution plans for their new employees. The savings, however, are illusory. Most of the state’s obligation to TRS is for contributions not paid during the past several decades. The deferred cost of underfunding cannot be eliminated by switching to a defined contribution scheme. In fact, it is likely that a defined contribution plan would cost more:
Changeover costs to a new defined contribution plan would be significant.
Ongoing costs for a defined contribution plan would be much higher than a defined benefit plan and would restrict growth of the defined contribution account balance.
In fiscal year 2006, the expense ratio of TRS was about 0.30 percent of assets; the average expense ratio of a private sector “target-date” defined contribution retirement fund was 1.29 percent, or 4.3 times higher.
Defined contribution plans typically do not include real estate and private markets, assets that each earned over 20 percent last year for a well-diversified TRS investment portfolio.
Reasons to Keep the TRS Defined Benefit Plan
Cost. Current defined benefit plans for state and school district employees are neither excessive nor expensive.
Continuity. Defined benefit plans encourage long-term teaching careers.
Protection. Illinois teachers do not have a Social Security safety net, so the defined benefit plan is the only guaranteed protection for their retirement security.
Performance. TRS investment performance ranks in the top quarter of all public funds for the past 10 years.