That fact is that what employers cannot afford to continue are defined benefit pension plans.
In defined benefit plans the benefit is soley derived from a formula; such as X percent times last salary, or an average of the last few years' salaries, increased or decreased by a factor representing the number of years employed by the company before retirement (years of service ).
In such plans, the actual dollar amount of an employee's pension benefit remains at whatever the fixed formula (defined benefit) says it is, no matter what.
It is the "no matter what" that employers cannot afford. The "no matter what" cannot take into consideration either how the underlying investments of the pension plan have performed, or are projected to perform, nor can they consider what is the mortality experience of those in the plan [are retirees living longer - on average - than was calculated when the "defined benefit" formula was established?].
With defined benefit plans, the "no matter what" means that when the stock market is down, and employers have less ability to raise capital, the value of the defined benefit pension plan is also down, and standard American accounting and actuarial advisors, and agencies like the SEC and the Federal Pension Guarantee Corporation, will insist that the company kick in additional money to the pension plan - right when they have less money on hand to do so. Why? Because the company has promised a fixed dollar amount of a benefit - no matter what.
Defined benefit plans provide similar problems when the the company is hit with the sudden occurrance of a large number of retirees in one year. No one can set aside the total lifetime payout of any pension benefit. The amount that is set aside is an amount that will pay a benefit and continue to grow somewhat as payments are made, so that the initial reserve plus what it earns over the expected term of the payments will provide the total needed. How much is needed? Enough to fund existing benefit payments currently being paid and enough to fund the start of new benefits for those working. And, when a large number of employees deside to retire in the same year, beyond what was anticipated, the fund is again going to suffer unexpected shortfalls of projected needs - for the short term - unless it kicks in additional funds so that the unexpected new payments do not reduce the reserves below "prudent" limits.
None of these issues arise in a defined contribution plan.
In a defined contribution plan, what the employer promises is to make a certain stated, fixed or flexible, level of contributions into the pension plan. Most such plans allow the employee to tax-shelter part of their salary, having a % of salary-earned deposited directly into the pension plan. My last employer who had this type of plan paid an amount equal to 14% of salary into the plan.
Most defined benefit plans offer the participant choices in how the contributions by them and by the employer are to be invested; with %'s allocated between higher earning and higher risk options and lower but stable earnings and less rsiky options; usually with combinations of those permitted.
And what is the benefit that is paid? It is essentially an actuarial calcualtion - how much is the total that was socked away plus the investment earnings and value growth on that total (the account), what is the mortality factor for the retiree (how many years of life expectancy from retirement to death), and what is a prudent level of expected investment return that the account continue to get while the benefits are paid.
The best of such plans invest 100% outside of the company, not in the company's own stock. This protects the exposure of the funds to the ups and downs of the company itself.
A defined contribution pension fund offers employers exactly what they cannot afford with defined benefit plans - the "no matter what" factor. In a defined contribution plan, the employer has no guessing about what is needed for the employees pension contributions - that, the employer's contribution is the one thing that is defined. Therefore, the employer's costs are always predictable and certain, no matter what the stock markets are doing today, no matter how many employees are retiring - or need to be given early retirement. The fund has in it whatever was contributed and whatever those invested contributions have earned. There is never a "crisis" to make up for the lack of predictability with defined contribution plans.
Unions, and particularly government unions, love defined benefit plans and hate defined contribution plans. They love the "no matter what" factor which alleviates any responsibility or sharing of risk on their part. And, those defined benefit, ofetn taxpayer financed, pensions are some of the highest pensions paid, when weighed against what the employees earned.
Financial problems for companies are mostly problems of risk, and financing to account for the risk. Defined benefit plans are financially untenable and they are not only banckrupting major corporations, they are turning public employee pensions into absorbing ever higher portions of what government must get from the taxpayers.
Get employers and government units out of defined benefit pension plans, put everyone on defined contribution plans and allot of the "pension problems" wll be reduced to manageable levels. Continue to pay some employees a formula benefit, no matter what, and we will all be bankrupt, under the cost of goods and the taxes to pay for the "benefits".
Excellent explanation of the differences. Few their be that make it through a thirty year career and then have the luxury of a defined benefit plan. Government workers, teachers, and some unions come to mind, but that doesn't mean that even those shouldn't be planning on their own.