DB Plans versus DC Plans

Lobster or Cracked Crab

DISCLAIMER

I am not giving financial advice. This presentation is to educate the audience about defined benefit and defined contribution plans. Also to educate the audience of fiduciary responsibilities and fee calculations.

Defined Benefit Plans vs. Defined Contribution PlansDefined Benefit Plans (DB) Defined Contribution Plans (DC)

A pension plan under which an employee receives a set monthlyamount (a defined benefit) upon retirement, guaranteed for theirlife. The lifetime monthly benefit amount is based upon theparticipant’s wages and length of service and benefit accrual rate.Funding is provided through employee contributions, employer contributions, and investment earnings.

A retirement savings program, such as a 401(k), under which certaincontributions (defined contributions) are made to a participant’saccount during employment, but with no guaranteed retirementbenefit. The benefit is based upon the contributions by the employee,which may be matched by the employer, and investment earnings ofthe plan. The benefit ceases when the individual employee depletestheir account balance.

Pros Cons Pros Cons

• Qualified investment managers invest pooled assets• Investments are managed over the long term, therefore asset allocation does not have to become more conservative over time• Investment returns are “smoothed,” making DB plans less volatile• COLAs may be granted as protection for inflation• DB plans can deliver any given level of benefit at a lower cost• DB plans guarantee a known benefit for the life of the retiree• Participation usually mandatory – requiring employees to save• Helps recruit and retain quality employees• Provides ancillary benefits such as disability, survivor, & spousal benefits such as life insurance

• Less portable - cannot put it in your will• Vesting usually 10 years• If benefits granted but not funded, plan will accumulate an unfunded accrued liability• Employer contribution rate varies• Employer responsible for poor investment performance• Employee/retiree cannot capitalize on Bull markets  

• Portable – you can put it in your will• Provides portability for non-career employees….can roll it over from job to job without having to serve 25 years.• Does not accumulation unfunded accrued liability for employer• Employers retain a steady contribution rate• Employee/Retiree can capitalize on bull markets.

• Investment risk is borne entirely by employees• Most employees are not equipped to make the best investment decisions• Employees are generally advised to transfer to more conservative asset allocations as they age, to lessen the chance of losing a large amount of assets prior to retirement• May create social costs due to poor investments or those who outlive retirement benefits (i.e. welfare)• No protection against inflation after retirement• There is NO implicit or explicit guarantee of retirement income in a DC plan• A market downturn at the time of projected retirement could delay retirement and/or reduce retirement funds• Participation not mandatory – employees can remove and spend funds before retirement

WHO BEARS THE RISK IN RETIREMENT SAVINGS

• DB PLANS (RSA) - In DB plans the employer bears all of the risk of the employee/retiree retirement account. The employer promises an amount and must provide it.

• DC PLANS (401k) - In DC plans the employee bears all of the risk of the employee/retiree retirement account. The employer gives a plan/account for the employee to use and is not responsible for the outcome.

How Does GASB 68 Effect DB Plans?

• GASB 68 is a policy that requires Employers to record the actuarial unfunded liability on the balance sheet as an obligation.

• It is just the same as getting an invoice from a vendor for $2,500,000.

• If your DB service provider has poor performance, it is your problem.

• Who chose if your company would have a DB plan or a DC plan?

• Who chose the DB Plan Sponsor? (RSA) Or the DC Plan Sponsor? (ING, Schwab, Fidelity)

• What happens if sponsor makes poor choices?

• Can we change what we have?

WHO MADE THE CHOICE OF PLAN?

CAN I GET A DB PLAN OTHER THAN RSA?

Bank of America will offer a DB plan to any company.

Prudential Insurance will offer a DB plan to any company.

Principal Financial Group will offer a DB plan to any company.

PENSION INSURANCE FOR DB PLANS

• PBGC Protects America's Pensions• http://pbgc.gov/• PBGC pays monthly retirement benefits to nearly

744,000 retirees in 4,000 pension plans that ended. PBGC is responsible for the current and future pensions of about 1,476,000 people.

• For 2014 the maximum guaranteed amount is $4,943.18 per month ($59,318.16 per year) for workers who begin receiving payments from PBGC at age 65.

• The ERS is a governmental retirement plan and is not insured nor is it required to be insured by the PBGC. The provisions of law governing the retirement system are established in state law. Employer contribution rates for member agencies are adjusted annually to help provide for the funding of retirement benefits. Retirement benefits are funded from employee contributions, employer contributions, and investment income. Employer rates are adjusted each year up or down based in part on how well funded the employing agency is.

Bill PaulERS Benefits

HOW RSA IS INSURED

TVA ends traditional pension for new hires employees, moves to 401(k) only benefits for new hires

By Dave FlessnerSaturday, June 28, 2014

For the first time in its 81-year history, the Tennessee Valley Authority will no longer offer employees hired after Monday (June 30) a traditional pension that pays a worker a monthly check for the rest of his or her life at retirement.TVA will become one of the largest electric utilities next week to give up the defined-benefit retirement plan in favor of making contributions to an individual 401(k) retirement plan. In the new plans, workers will retire with a lump sum payment based upon what they and TVA contributed to the 401(k) plan and what investment returns were earned on the money over time.

9Appendix. Ratio of Assets to Liabilities for State/Local Plans 2001, 2004, 2007-2012, and 2013 Estimates

Plan name 2001 2004 2007 2008 2009 2010 2011 2012 2013

Alabama ERS 100.2 89.7 79.0 75.7 72.2 68.2 65.8 65.7 69.5 Arkansas ERS 105.6 88.7 89.1 89.7 78.0 74.1 70.7 68.9 74.3 Georgia ERS 101.7 97.6 93.0 89.4 85.7 80.1 76.0 73.1 71.4 Kentucky ERS 125.8 85.8 58.4 54.2 46.7 40.3 35.6 29.7 25.8 Mississippi ERS 87.5 74.9 73.7 72.9 67.3 64.2 62.2 58.0

57.7South Dak ERS 96.4 97.7 97.1 97.2 91.8 96.3 96.4 92.6 100.0

THE FUNDING OF STATE AND LOCAL PENSIONS: 2013-2017 By Alicia H. Munnell, Jean-Pierre Aubry, and Mark Cafarelli * *

Center for Retirement Research at Boston College

FIDUCIARY RESPONSIBILITIES OF DC PLANS• What does FIDUCIARY mean? a person in a position of

authority whom the law obligates to act solely on behalf of the person he or she represents and in good faith

• Who is the trustee of your DC plan? It may be you

• What are the responsibilities of the trustee? (a) Choose a Plan provider (b) Develop investment objectives (c) Educate the participants

• Is the trustee liable for a poor plan? Ask Caterpillar

3 Areas of Fiduciary Responsibility

1. Plan investment options-ensure that the plan options are appropriate and in accordance with the plan’s investment policy statement.

2. Remittance of participant contributions-Participant contributions should be remitted on the earliest date.

3. Plan Definition of Compensation - The plan must define the inclusion or exclusion of payments in compensation, such as bonuses, vacation, overtime, fringe benefits and commissions. Manual payroll checks without proper consideration of the plan’s definition of compensation, can quickly result in costly compensation errors.

Investment Policy StatementPlan and Trust Name: Scottsboro Electric Power Board (“Plan”). This Investment Policy Statement is adopted for the Plan by Authorized Trustee(s) (Plan Fiduciary). The Plan provides for individual accounts and permits participants (or beneficiaries) to exercise investment control over the assets in their accounts.

The Plan’s overall investment objective is to provide Plan participants (or beneficiaries) with a sufficient variety of investment options to enable participants to achieve their individual investment goals for retirement. To accomplish this, the Plan may enter into group annuity contracts or agreements with financial services providers that offer a wide variety of investment options and benefit distribution facilities. The investment options should represent multiple asset classes covering equity (stock), fixed income (bond), money market or stable value, and balanced options/Lifestyle/Lifecycle. These investments will have the following general characteristics.

*Different risk/return characteristics*Different investment objectives and styles;*Annualized returns over three-, five- and ten-year periods that have met or exceeded the competitive averages or established industry benchmarks; and*Reasonable operating expenses and/or minimum guaranteed rates of return, as applicable, that are disclosed to participants

• What kind of DC plans are available?• 401k• 457• 403b

How Do You Pay for a DC Plan?

• Who pays the fees for a DC plan?– Some employers pay for the fees– Most plans, the employees pay the fees from their

account balance. AUM (Assets Under Management)

– Institutional shares , A shares, C shares

What is so important to understand DC Plan fees?

1. Assume same investment of $25,000

2. Person A has .5% expense ratio and Person B has

1.5% expense ratio

3. The 2 instruments appreciate equally by 7% for the

next 35 years

WHAT IS THE SIGNIFICANCE OF 100 BASIS POINTS?

Who cares about fees?

The Significance of Fees is Simple

• Person A (7% returns and 0.50% costs) @ 35 Years = $227,000

• Person B (7% returns and1.50% costs) @ 35 Years = $163,000

$64,000!

Person A gains 39% relative to B

TRADING PLACES

• A movie with Eddie Murphy and Dan Akroyd where at the end the butler asked them what they wanted for dinner…..lobster or cracked crab?

• The reply was…. Let’s have both.

• I suggest that you have a DB plan and a DC plan to supplement the pension and provide for inflation protection.

RSA Pension55%

Social Security30%

Savings15%

Replacing Income During RetirementAssume that you must replace salary of $50,000

Annual FISCAL Checkup

• Do you have a will?• Check your beneficiaries on your company life

insurance.• Check your beneficiaries on your RSA account.• Check your beneficiaries on your brokerage

account(s).