Traditional Defined Benefit Plans Are Hard to Manage

The Facts

  • Defined Benefit plans require governments and plan managers to make a number of complex calculations about demographic and market trends in order to determine the amount of money they must save now to cover the cost of providing benefits to future retirees.
  • The complexity of Defined Benefit plans also makes it difficult for taxpayers and workers to determine whether politicians are managing the pension funds in a responsible manner and to hold them accountable for their decisions.

Traditional Defined Benefit plans make it easier to divert funding

There are several aspects of traditional Defined Benefit pension plans that promote poor fiscal management practices. First, Defined Benefit plans require governments and plan managers to make a number of complex calculations about demographic and market trends in order to determine the amount of money they must save now to cover the cost of providing benefits to future retirees. These calculations include predictions about variables that are highly uncertain, such as investment returns, life expectancy, and worker tenure. Even small errors in a government’s estimate of these variables can lead to significant funding problems down the road if cities and states fail to save enough money to cover their retirement promises.

The complexity of Defined Benefit plans also makes it difficult for taxpayers and workers to determine whether politicians are managing the pension funds in a responsible manner and to hold them accountable for their decisions. Given that workers do not collect their retirement benefits until many years after governments should pay for them, traditional Defined Benefit plans make it easier to divert funding from the pension system. As such, some cities and states pay less than what is needed to ensure their plans remain financially healthy in order to cover their immediate expenses—a move that can lead to exponential growth in pension debt due to compounding interest and far greater pension costs for the next generation of workers and taxpayers.