Many academic and government jobs offer state or municipal defined-benefit (pension) plans, or you can elect a defined benefit plan (where the company matches your contributions to a 403(b) or similar account. Which should you choose?
Pensions are getting Rarer and Worse
First, some context: Many universities and agencies have moved to nudge workers out of the pension plans while continuing to offer them. For instance, my institution’s pension plan has a 10-year vesting period, which means you need to work here for 10 years before you get the lowest pension support. If I’d started working here 5 years earlier, the vesting period would have been 5 years. Obviously, a 10-year wait is unappealing to many tenure-track faculty (by design), since they don’t know if they’ll get tenure in 6 years. I don’t have the numbers, but I imagine few of my colleagues chose the defined-benefit plan.
And, of course, my university is exceptional among the bigger universe of employers in that it still offers a defined-benefit plan. The Bureau of Labor Statistics estimates that only 15% of private sector workers have access to a defined-benefit plan, while 86% of state/federal government employees still do. So it’s frustrating that they’ve become less generous, but access to them is still a perk of working in academia, at least in public schools.
The Timing of the Decision Sucks
The other frustrating thing about having the choice between a defined-benefit and defined-contribution option is that you sometimes have to decide which retirement program you’ll enroll in right when you first start your job. That means you need to make a decision that you may never have thought about before while you’re in the middle of moving, enrolling your kids in school, finding your office, meeting your colleagues for the first time, and wondering how the heck you’ll publish enough to get tenure on top of your teaching and service and family obligations. I don’t think I thought about it very long, and I doubt I’m alone.
How a Defined-Benefit Plan Works
If you enroll in a defined-benefit program, a percentage of your monthly paycheck will contribute toward this pension plan. You’ll get it back if you leave your employer without vesting first, but you won’t get the market gains you would have had if you’d invested it. Typically, you get certain benefit levels depending on how long you work at your institution (or the state that runs the pension), proportional to your salary. Your employee retirement handbook will have more information, and if you still have questions, you should reach out to your HR office or the group that runs the pension plan.
The best part about this type of retirement plan is that it promises that you’ll receive monthly payments subject to the benefits formula (some function of salary times service time times some multiplier) until the day you die, and then your surviving spouse will get it if you have one. If the plan is well-run and committed to supporting their retirees, that’s a hard benefit to beat — think of it like tenure, but for retirement!
How a Defined-Contribution Plan Works
This is pretty simple: You contribute a certain percentage of your (usually pre-tax) income to your 403(b) or similar tax-protected retirement account, and your employer will match it in some ratio. Sometimes this will be 1:1, like a 5% (employer):5% (employee) match. Sometimes the employer will match at greater than 1:1, and sometimes less. The higher the ratio and the higher the percentage of your salary that match at that ratio, the more generous the program. Usually your contribution is mandatory if you sign up for this program, but sometimes you just get matched up to whatever limit is designated.
So, let’s suppose your monthly paycheck is $5,000 and you have a 5%:5% 403(b) match. That means that every month, your employer will withhold $250 from your check (5%), add $250 to it (not from your check), and put it in your 403(b) account. When your salary increases, so do those contributions. If your employer’s plan is very generous and offers a 10%:5% match, they would add $500 to your $250 every month. It’s not a bad deal. However, a few things to keep in mind here:
- You’ll need to decide how to invest this money yourself. Usually your employer or the plan administrator will make advisors available to help, but it’s ultimately up to you. Depending on your money psychology, you may find that stressful.
- When you retire, you’re on your own. If your account craters the day after you retire, neither your university nor TIAA are coming to save you. You’ll sink and swim with the markets.
- The upside, of course, is there’s no vesting period. That money is yours the second it hits your account. And if you move jobs, it’s easy to take it with you.
Considerations If You Have to Choose
If you do have a choice between appealing defined-benefit and defined-contribution programs, your preference may hinge on the details of the institution and your situation:
- If your early career is successful, would you still want to be at your current institution when the vesting period is over? (If so, that’s points for the defined-benefit plan, all else equal.)
- If your early career is unsuccessful, would you be able to last long enough to vest? (If not, that’s points for the defined-contribution plan.)
- How comfortable are you self-managing your retirement finances? (If comfortable, that’s points for the defined-contribution plan.)
- How well-run does your state’s pension program appear to be? (If well-run, that’s points for the defined benefit plan.)
But You May Not Have to Choose!
With those considerations in mind, remember that even if you choose the defined-benefit program, you can still often invest in a 403(b) or similar account up to the annual personal contribution limit. Sometimes, you can even participate in the defined-benefit and the defined-contribution program, though the latter is probably voluntary if both are offered. Either way, you can be in the defined-benefit program without only being in the defined-benefit program.