Alaska Public Pension Coalition

FAQ: Defined benefit plans v. defined contribution plans

A defined benefit plan is a retirement plan that provides a guaranteed retirement income and one that cannot be outlived.

A defined contribution plan is a retirement plan whereby the employer, employee or both make contributions towards an individual account established on behalf of the employee. The benefit to employees at retirement is based on contributions to the plan and investment earnings in the plan. An individual can outlive a defined contribution plan. A defined contribution plan is sometimes referred to as a 401(k).

FAQ: Do defined contribution plans provide enough money?

National studies show more than 66% of defined contribution plan participants cashed out their accounts when terminating employment and did NOT roll the funds into any other retirement fund. National studies also show the medical 401(k) fund balances with household heads ages 55-64 was $50,000. Just one major illness would wipe out that amount.

Unlike a defined benefit retirement plan, defined contribution retirees would not be eligible for any cost of living adjustment. Why is this important? Financial experts report that an inflation-indexing, such as a post retirement pension adjustment, can increase the value of the benefit system by as much as 40%.

FAQ: Isn't a defined benefit system more expensive?

No.  The costs of Tier III and the Defined Contribution are about the same, even without considering factors such as training new employees, loss of productivity due to frequent turnover, overtime paid due to vacant positions, etc.

FAQ: Doesn't the defined benefit system create a huge financial burden?

No.  As in all defined benefit retirement systems, the large majority of the funds to pay for all retiree benefits (including the cost of living adjustment and that post retirement pension adjustment), come from the return on the investments of the retiree funds. Typically, more than 62% comes from the return on investments.

FAQ: Don't people in a defined contribution plan have Social Security?

No!  Neither teachers nor most public employees in Alaska are part of the Social Security system, and therefore cannot receive anything in retirement from Social Security. By contrast, every employee of a private company participates in Social Security.

FAQ: Can't individual investors get better returns?

Most financial experts don’t think so. Large institutional investors such as public pension funds have access to a wider diversity of funds, some of which are not available to individual investors. With some of the top professional investment managers in the world, pension funds earn returns that individual investors find very difficult to match. For example, the Alaska public pension funds had a rate of return of 18.9% for FY07.

FAQ: Do individual investors make their own decisions on where to invest?

The reality is only about 5% of the thousands of new employees in the Defined Contribution Plan are making their own investment decisions.  The other 95% are NOT making the investment decisions themselves. 

FAQ: If retirees leave the state, what impact will be felt on the economy?

Significant.  Decades ago, retirees left the state. Today, about 2/3 of public employee retirees remain in Alaska.

Here are some figures from a September 2006 economic analysis of the impact of seniors/retirees in Alaska:

• They infuse $1.46 BILLION into the Alaska economy each year.
• These expenditures generate 11,700 jobs in the Alaska economy, throughout the State, because most of the retirees’ money is spent locally.
• Retirees provide formal and informal volunteer work worth an estimated $13 million to $52 million annually.
• Retirees provide care giving to other Alaskans valued at $47 million annually.

 

FAQ: Will defined contribution retirees have a good medical plan?

No.  To be eligible for ANY medical benefit, the retiree must meet a list of qualifications:

• Employee must have at least 30 years of service (or 25 years for police officers or fire fighters) OR be ‘normal retirement age,’ i.e., eligible for Social Security  PLUS at least 10 years of service.
• Employee must have been working continuously for employer for 12 months before retirement.
• Employee must “retire directly” from the employer.

FAQ: What retiree medical benefit is provided under a defined contribution plan?

Let’s say we have an employee who has met EACH of the criteria list in the previous question.  What Retiree Medical Benefit will be provided?

The Retiree Medical Benefit has two components:

1. It provides ACCESS to a retiree major medical plan, but the retiree must pay 100% of the premiums until he/she is eligible for Medicare (at age 65). At age 65, the retiree must still pay premiums.
2. It provides ACCESS to a Health Reimbursement Arrangement [HRA]. A HRA is an individual account paid for by the employer at 3% of the employer’s average annual employee compensation, which can be used to pay the retiree major medical plan premium and can be used to pay for medical expenses. But once this HRA fund is depleted, the retiree is responsible for ALL medical expenses.