Comment by vkou | Hacker News Reader

Comment by vkou | Hacker News Reader

Parent Full thread

Defined benefit pension plans are a great idea, because you get something out of them, regardless of how long you live.

Even if investing in one makes you take a haircut, compared to a fixed contribution fund, they are still a great idea. For two key reasons.

1. You need money to live.

2. You don't know how long you'll live for.

If I retire with a fixed contribution retirement fund, that is planned to last me 20 years, and I die after year 5, it's of zero consolation to me that ~75% of my fund is still around.

... But if I live to year 21, I've now got zero income. A big fat zero. And I'm also not in a great physical state to work for more money to support myself.

Likewise, if there's a market crash, and a slow recovery two years into my retirement, that 20 years of runway may turn into 12.

Banking on a fixed contribution fund is like playing a game where we flip a coin. Tails, you triple your money. Heads, you lose everything you own.

This game has a positive expected net value for you, but you'd be an absolute idiot to play it at the age of 75.

With a defined benefit pension plan, you're playing a different game. Heads, you add 40% to your money. Tails, you lose half of what you own.

This game has a negative expected net value for you, but if you have to pick between one or the other, it's a much better game to be playing at the age of 75.

The optimal strategy, of course, is to diversify your investments, and have both a defined contribution retirement fund, AND a defined benefit pension plan, with the understanding that one of them may underperform for your situation. (The first if you live too long, the second, if the market in general has a rough time.)

Currently, something like 4-6% of my retirement 'savings' (In the form of social security contributions) are tied in defined benefit pension plans. I'd feel much more comfortable if I could shift my distribution of savings, so that they would be closer to 30% of them. And yes, I expect to take a haircut on them.

Most financial risk can't be reduced, only shifted around between parties. The problem with defined benefit pension plans is what happens when the sponsoring entity goes bankrupt and can no longer pay? It's just too risky and the existence of the PBGC actually exacerbates that risk, creating a huge moral hazard at taxpayer expense.

And as for a market crash two years into retirement, only an idiot would be in volatile assets at that stage. The default investment option for most defined contribution plans is a target date fund, which protects against that scenario.

> Most financial risk can't be reduced, only shifted around between parties. The problem with defined benefit pension plans is what happens when the sponsoring entity goes bankrupt and can no longer pay?

You take a haircut, and your pension ends up getting reduced to ~70% of what you were going to get paid. That's the "Flip a coin, and lose scenario". But at least you're still getting paid.

These funds don't magically drop to zero out of the blue, and neither will social security (Which is the biggest example of a defined benefit pension fund.)

> And as for a market crash two years into retirement, only an idiot would be in volatile assets at that stage. The default investment option for most defined contribution plans is a target date fund, which protects against that scenario.

Keeping all your money in safe, zero-return investments doesn't protect against the scenario of 'you lived longer than expected'.

My parents have recently retired. They aren't keeping every penny of their money in a zero-return mattress. If they did, it would run out when they hit 82. Investment orthodoxy agrees with them - it instructs that when you are 70, you should have ~30% stocks.

If you follow that orthodoxy, and get a recession a bit into your retirement, and live longer than expected, you are going to be old and broke, but I suppose you'll feel really smart for not getting hoodwinked by one of those defined payment pensions...

The thing is that to prepare for retirement, you cannot have a plan where you accrue a lump sum that you then draw down.

The only plan that can works is if you accrue a large enough amount, from which the interest earnings are enough to sustain you indefinitely (using a low interest but safe returns instrument like high grade bonds and gov't bonds, with a small mix of stocks selected for dividends). The expectation is to earn some 2-4% interest in aggregate, and that should amount to some $20-30k USD per year (after tax, if taxed - preferably work out how to get good tax treatment). That works out to be between $900k-1mil USD.

If you cannot hit this target by the expected time you need to retire, then you're already fucked. That's why retirement planning should start when you start your first job.

> The only plan that can works is if you accrue a large enough amount, from which the interest earnings are enough to sustain you indefinitely (using a low interest but safe returns instrument like high grade bonds and gov't bonds, with a small mix of stocks selected for dividends).

I don't plan to stay alive indefinitely, though, so I don't need a plan that will sustain me indefinitely. That is overkill, and most people can't afford to save that up.

What I, and most people need is a plan that will sustain the retiree until they die - and not just for an average case scenario.

Pension plans have lower expected returns, but handle the long-tail cases well, because they balance risk between different participants - some of whom die early, and some of whom die late. Someone who dies five years after retirement will draw much less from a pension than someone who dies twenty five years after retirement. The existence of the former provides safety for the existence of the latter.

401Ks have higher expected returns, but handle long-tail cases poorly, because there is no diversification of risk for the individuals participating in them. I may end up dying with 90% of my 401K in the bank. That does me no good. I may end up saving up to live into my 80s... Only to discover - too late - that it wasn't enough.

> That is overkill, and most people can't afford to save that up.

If you start when you're 20 (so 40 years of compounding time for a retirement age of 60), a $500 monthly savings contribution, on a 5% growth of stock investment (which, tbh, is low for such a long period), should net you some $745k (with $240k contributed, $500k interest earnings).

Is $500 a month of contributions a lot? I dont know - it depends on your income. But i think for a large portion of the working population, this is doable. It does mean sacrifice if your income is on the low end - you don't ever go on a holiday, you don't drive a new car (but instead, buy an old one so you don't have debt to service). You probably won't own property, and will continue to rent (and i'd include rent costs in the $25k in retirement cost per anum). It's not a fancy lifestyle - but it does mean you don't rely on a gov't social security, you don't rely on a pension fund that could go away.

And the end result is you will have some money left over when you die to contribute to either your children if you got any, or choose to donate/contribute to a cause you find worthy.

Under a pension plan, the person who dies early then leaves their children behind with nothing (or lost the contributions they would've deserved had they remained alive - albeit subsidizing somebody else's longer life). I don't find that fair, since a pension is part of your employment compensation, and yet you don't extract it all if you died, and thus you actually lose out.

Setting aside $500 every month in your 20s for a maybe event in your 80s is an unrealistic expectation for most of the population outside of Bay Area

> Under a pension plan, the person who dies early then leaves their children behind with nothing (or lost the contributions they would've deserved had they remained alive - albeit subsidizing somebody else's longer life). I don't find that fair, since a pension is part of your employment compensation, and yet you don't extract it all if you died, and thus you actually lose out.

Yes, that's the point of a pension plan. It's not a 'inheritance savings plan'. It's not intended to support your aging adult children. It's intended to support you... So that they don't have to.

What's really unfair to your children is you living to 90, and expecting your kids to support you, when they are 70, because your 401k money has run out five years ago. That's going to do wonders for their retirement prospects, no doubt.

if landlords find out everyone is putting away $500/month, you can be sure rents will go up by $500/month

> Under a pension plan, the person who dies early then leaves their children behind with nothing

Someone doesn't understand survivors benefits.

Reply on news.ycombinator.com