DC Plans Help Short-Term Public Employees

November 20, 2012 (PLANSPONSOR.com) Adding a defined contribution (DC) component in public retirement systems provides for a more equitable distribution of benefits between short-term and career employees.

This is the contention of the latest brief from the Center for Retirement Research at Boston College, which claims two aspects of plan design leave many of these workers with little or no accrued benefits. First, public defined benefit (DB) plans are based on final earnings, under which those who leave early receive little. Second, employee vestingthe period of service needed to qualify for any pension benefittakes five or ten years.   

The report notes that in most cases, participants who leave before vesting receive only their own contributions plus some low rate of interest. The researchers’ analysis indicates nearly half of workers leaving state and local employment depart without any promise of future benefits.  

In addition, in almost all cases, public DB plans calculate the initial benefit at the full retirement age as the product of three elements: the plan’s benefit factor, the number of years of employee service and the employee’s average earnings—generally based on the three to five years of highest earnings. As a result, an employee starting at age 35 with a 30-year career will earn more than 30% of lifetime pension benefits in the last five years of employment, but those leaving with 10 years of service receive about 14% of the possible lifetime benefits.  

“Final earnings plans produce strongly back-loaded benefits and, when combined with delayed vesting, deprive short-term employees of retirement protection, especially for those systems that do not participate in Social Security,the researchers conclude. Therefore, some mixture of defined benefit and defined contribution plans will produce a better balance between the benefits provided to short- and long-tenure workers.”

The brief can be downloaded from here.