As a New York State and Local Retirement System (NYSLRS) member, your pension is part of a defined-benefit retirement plan. According to a report from the National Institute on Retirement Security (NIRS), public employees overwhelmingly choose a defined-benefit plan over a defined-contribution plan, when given the choice. But, what are the differences between the two?
According to the Internal Revenue Service (IRS), defined-benefit plans provide a fixed, pre-established benefit for employees at retirement. The defined-benefit plans administered by NYSLRS:
- Provide a guaranteed lifetime retirement benefit;
- Offer a pension that is based on final average salary and years of service;
- Provide a right to pension benefits (vesting) with five years of service credit (ten for Tier 5 and 6 members);
- Build a cost-of-living adjustment (COLA) into pensions to help offset the effect of inflation;
- Include disability and death benefits; and
- Favor long-term public employment, because benefits are tied to years of service.
With a 401(k)-style defined-contribution plan, employees can make contributions from their paychecks either before or after tax, depending on the plan. Employees often choose where to invest these contributions, among the options provided under the plan. In some cases, the employer also makes contributions (such as matching employees’ contributions up to a certain percentage).
If employees change jobs, they can:
- Leave the 401(k) money where it is;
- Roll it into an individual retirement account (IRA) or another 401(k); or
- Cash out the account.
At retirement, retirees usually decide how to spend their retirement savings on their own. Since the value of the account will fluctuate due to investment gains and losses, defined-contribution plans — unlike defined-benefit plans — may not provide a reliable monthly income at retirement.
Also, defined-contribution plans don’t provide death and disability benefits to survivors. (Though, employees may be able to make extra contributions for death and disability benefits outside of the defined-contribution plan.)
Cost Effectiveness Comparison
Numerous studies have suggested that defined-benefit plans cost less than defined-contribution plans in the long run and perform better. In fact, according to the model in a recent NIRS report, defined-benefit plans cost 46 percent less than individual defined-contribution plans for several reasons:
- Defined-benefit plans avoid longevity risks. To avoid running out of money, an individual investor in a defined-contribution plan needs to save at a rate that ensures their funds will last well into their nineties. Because they work with large pools of retirees, defined-benefit plans can save for the average life expectancy. As a result, they save 15 percent compared to defined-contribution plans.
- Defined-benefit plans can maintain an optimal asset allocation. Financial advisors urge individual investors to make higher-risk/return investments when they are younger and shift to lower-risk/return investments as they age, so their funds will last through their retirement. On the other hand, defined-benefit plans do not age like the individuals in them do. They are able to take advantage of the enhanced investment returns that come from maintaining balanced portfolios over long periods of time.
- Defined-benefit plans achieve higher investment returns. With professional management and lower fees, investment returns increase by 1 percent each year over an individual’s career. That adds up to a 26 percent savings for defined-benefit plans versus defined-contribution plans.
By administering a reliable, cost-efficient and sustainable defined-benefit plan, NYSLRS helps members ensure their financial security in retirement. To find out more about your specific retirement benefits, please read your retirement plan publication.