Members often ask why TRS strongly supports the defined benefit (sometimes referred to as DB) approach to retirement security. In a nutshell, a defined benefit plan is more certain. One cannot outlive the benefit. In addition, the benefit does not change or drop when stock markets falter.
At TRS, the current benefit formula is defined as 2.2 percent times final average salary times years of creditable service. Prior to 1998, a graduated formula was in effect.
In a defined contribution (sometimes referred to as DC) plan, like a 401(k), 403 (b), or 457 plan, only contributions are defined. The member’s benefit is not. It is determined by how well the member invests the account and market conditions at retirement. Unfortunately for some, earnings may fall short, or the member may outlive the defined contribution account.
Defined contribution will not save money
A few states have adopted defined contribution plans for their new employees. In Illinois, some lawmakers and business leaders want to shift future employees to defined contribution plans in order to “save money.”
The savings, however, are illusory. Most of the state’s obligation to TRS is for contributions not paid during the past several decades. The deferred cost of underfunding cannot be eliminated by switching to a defined contribution scheme. In fact, it is likely that a defined contribution plan would cost more:
- Changeover costs to a new defined contribution plan would be significant.
- Ongoing costs for a defined contribution plan would be much higher than a defined benefit plan and would restrict growth of the defined contribution account balance.
- In fiscal year 2006, the expense ratio of TRS was about 0.30 percent of assets; the average expense ratio of a private sector “target-date” defined contribution retirement fund was 1.29 percent, or 4.3 times higher.
- In fiscal year 2004, the median cost of public defined benefit plans was 0.3 percent of assets; the median cost of defined contribution plans was 1.4 percent, or 4.7 times higher.
- Defined contribution plans typically do not include real estate and private markets, assets that each earned over 20 percent last year for a well-diversified TRS investment portfolio.
Reasons to keep the TRS defined benefit plan
- Cost. Current defined benefit plans for state and school district employees are neither excessive nor expensive.
- Continuity. Defined benefit plans encourage long-term teaching careers.
- Protection. Illinois teachers do not have a Social Security safety net, so the defined benefit plan is the only guaranteed protection for their retirement security.
- Performance. TRS investment performance ranks in the top quarter of all public funds for the past 10 years.
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