Employer-sponsored retirement plans generally fall into two broad categories. APERS operates what is known as a “defined benefits” pension plan whereas most private retirement plans are “defined contribution” plans. The basic difference is what each plan promises its participants.
A defined benefit plan (APERS) specifies exactly how much retirement income employees will get once they retire. A defined contribution plan only specifies what each party – the employer and employee – contributes to an employee’s retirement account. Of course, it’s a bit more complicated, so we will examine each type in more detail.
Defined Benefit (APERS)
A defined benefit or “DB” plan, such as the one offered by APERS, guarantees a specific monthly pension based on a formula. In APERS case, when a member retires the formula calculates a monthly payment based on the member’s average salary (highest 3 years), length of service, and a percentage set by law. This payment continues for the life of the retiree. The money comes from the general funds of the plan. The member has no individual retirement account with a fixed amount of money that can be exhausted, so they member cannot outlive his or her retirement funds.
So one of the great advantages of DB plans is their predictability. From the moment employees enter a DB plan, they can calculate exactly what benefits they will receive when retiring under a specific set of circumstances. The longer they work and the higher their salary, the greater their benefit will be, and once it is set it will not change. Of course, the second great advantage is security since the payments continue for life and in some cases beyond if the member chooses a beneficiary option. DB plans like APERS work best on a large scale. They need a high number of contributors to help maintain consistent funding levels, and they require expert statistical analysis to predict trends and guide adjustments. Few private companies possess these resources.
Unlike APERS' DB plan, in a defined contribution or “DC” plan each employee has a separate taxdeferred investment account. The account is funded by contributions from the employee and employer at a rate that is usually spelled out or defined in the employment agreement – hence the name. When employees retire, they take their account with them with whatever assets it has accrued. Although the employer’s contribution is defined, it is impossible to know at any given point how much the account will be worth when the employee retires because the investments in it will be influenced by market forces and other variables beyond the control of employer or employee. The familiar IRA and 401(k) accounts work this way.
DC plan members usually have some control over where and how the funds in their accounts are invested. If the investments perform well, the employee prospers accordingly, but if they don’t then the benefits suffer. Even short-term losses can be significant if they occur when the funds are needed. The amount accrued in the employee’s account at retirement constitutes the whole of the retirement benefits. If the account is ever exhausted, then so are the benefits, and members can outlive their retirement fund.
Stability and Predictability
Any retirement plan will be affected by the general health of the economy and by the performance of the investments that it makes. However, a DB plan removes the risk from the individual and places it on the plan itself. Although APERS members aren’t going to get rich overnight with some clever investment in their retirement account; they’re not going to lose it all in a crash either. They enjoy the security that only a defined benefit can bring.
Article from "APERSpective" Active Members Newsletter - Winter 2019