Grim Facts Support Defined Benefits

Inside Higher Ed today points to the issue of encouraging retirement of senior faculty and notes a report by the American Council on Education (ACE) about legal issues surrounding age discrimination, etc. Both items discuss the history of federal age discrimination law including the ending of mandatory retirement ages for faculty.

Although the ACE report mentions that there are two types of pension plans – defined benefit and defined contribution – it doesn’t emphasize the obvious point. There is no particular retirement incentive under defined contribution plans, which are basically tax-favored savings accounts. You can continue to accumulate contributions to such plans indefinitely.

In contrast, with defined benefit plans there are strong incentives built in to retire. Yes, you can add special incentives to defined benefit plans, as UC did with its VERIP programs in the early 1990s during a budget crisis. But, again, the incentives to retire are an integral part of defined benefits.

It is worth emphasizing why that is the case. Many people think that the incentive comes because the benefit is capped (at 100% of base pay at UC) and because the age factor ceases to rise after a certain point. That is only part of the story, however. There is a progressively strong incentive that comes out of the fact that each additional year of service is one less year of pension.

No one knows how long they will live. But everyone knows they will die for sure. (Sorry to have to point that sad fact out.) That basic existential truth means that the expected present value of your pension begins to decline; for each year you work, you must subtract out that effect from your salary to determine your net pay. If you are 65 and the fates have determined you will die at 80, retiring will give you 15 years of pension. If you choose to work, you will get only 14 years of pension, then 13, 12, etc. Eventually, you will be working for very little and even nothing, particularly if you reach retirement age after a period of long service. That outcome will be true whether you take your pension as an annuity or a lump sum.

When the issue of revising the UC pension came up, there was strong support for retaining the defined benefit format. It was seen as not just an advantage for faculty but also as a desirable personnel policy for UC, precisely because it encourages retirement without running afoul of age discrimination laws. Most private universities and some publics have defined contribution plans such as TIAA-CREF. Those plans were typically set up when mandatory retirement was legal and the issue of encouraging retirement did not arise. Now such universities face a problem UC does not have.

The Inside Higher Ed article is at http://www.insidehighered.com/news/2011/07/12/how_colleges_can_avoid_legal_pitfalls_when_designing_retirement_incentives_for_faculty

The ACE report is at http://www.acenet.edu/AM/Template.cfm?Section=Faculty_Career_Flexibility&Template=/CM/ContentDisplay.cfm&ContentID=41776

If you have questions, be sure to meet with your benefits counselor: