Why a teacher’s defined benefit retirement plan outshines a 401(k)

The vast majority of Colorado teachers will have a more
stable, secure retirement because of Colorado PERA’s defined benefit style
retirement plan, compared to a 401(k)-type option. That’s according to a new
report jointly released by the National Institute on Retirement Security
(NIRS) and the UC Berkeley Labor Center.

Critics of public pensions often argue that high attrition
rates among new teachers mean that 401(k)-type retirement plans make more
financial sense than established defined benefit (DB) plans for all educators.
These contentions usually include claims that choosing, or being forced into,
401(k) plans wouldn’t harm teachers’ retirement security in the long run. But
new research suggests that these conclusions are based on narrow interpretations
of employment data and that they could hardly be further from the truth.

The study lays out compelling evidence that migrating
teachers away from existing pension plans like Colorado PERA’s and into 401(k)
savings options “would sharply reduce the retirement income security of
teachers who account for a large majority of educational labor.” The report
adds that such moves hamper teacher recruitment and retention, resulting in
lower educator quality.

The study examined six states—Colorado, Connecticut,
Georgia, Kentucky, Missouri, and Texas—chosen because they represent a
geographic and demographic cross-section of the United States. Researchers found
that 65 percent of all teachers will have worked for at least 20 years before
they leave their careers, and that 77 percent of teachers’ retirement benefits
will surpass what they could receive under an idealized 401(k) plan—meaning, a plan with low fees and professional
management.

Skeptics tend to lean heavily on high turnover rates among young teachers when making their anti-pension arguments. While it’s true that a higher proportion of younger teachers leave for other professions during their first five years, once they’ve cleared that threshold, attrition drops sharply and remains low until retirement age. In fact, the “typical” teachers studied will serve 25 years in the same state and retire around age 58; in Colorado, the median age teachers retire is 57, after a median total of 17 years of service, and 48 percent of all Colorado teachers will stay in the profession until retirement age. See this graphic.

For those who have committed to teaching as a career, the
debate between a DB plan and a 401(k) is no contest: According to the authors, 81
percent of Colorado’s teachers are economically better off choosing the PERA DB
plan versus an idealized 401(k) plan with a 0.25 percent annual fee (compared
to a 77 percent average for all six states in the study). Not only that, any
teachers who start working at age 25 and serve for 30 years would have to
contribute 100 percent more every pay period into their 401(k) to earn the same
benefit as they would get from their DB plan contributions; in effect, they’d
have to double what comes out of each check—while tracking and adjusting their
own investments—just to barely equal their no-maintenance DB option.

Further, the PERA DB plan account is portable and can be left for a future benefit or rolled over to another retirement plan. Members always receive the value of their contributions (plus interest and if eligible a matching amount) when withdrawing an account – something that promoters of 401(k)-type plans often mischaracterize or fail to mention. Evidence of the value of PERA’s DB plan was presented in 2015 when an independent evaluation found PERA’s DB retirement plan to be more efficient and effective than other types of retirement plans, including 401(k)s.

See Pensions are Better infographic.

Defined benefitAlso known as a pension, this is a type of pooled retirement plan in which the plan promises to pay a lifetime benefit to the employee at retirement. The plan manages investments on behalf of members, and the retirement benefit is based on factors such as age at retirement, years of employment and salary history.