Types of Pension Plans in East Lansing

Sunday, April 29, 2018, 12:57 pm
By: 
Chris Root

East Lansing first established its retirement system in 1947, and all covered employees were in “defined benefit” (DB) plans. DB plans promise employees who qualify, by working a certain number of years, that they will receive a certain amount (a “defined benefit”) after retirement for the rest of their lives.

Defined benefit plans create a financial liability for the employer. The employer must cover the promised payments by paying whatever amount isn’t covered by investment earnings and contributions from employees.

The retiree’s pension benefit is based on a formula: [final average compensation (FAC)] x [number of years of employment] x [benefit multiplier]. The amount of the employer’s payment is also affected by the plan’s investment earnings and various actuarial assumptions, such as the expected lifespan of people in the plan and when they will retire. (MERS has produced a short video explaining how DB plans work.)

By contrast, in a “defined contribution” (DC) plan, employees pay some portion of their earnings into an employer-sponsored retirement account – which may be matched with some amount paid by the employer. Employees withdraw earnings and principal during retirement, or some plans allow them to “annuitize” the account by converting it into a guaranteed income stream for a specified period, such as the lifetime of the employee.

With a DC plan, the employee, not the employer, is at risk if investment earnings are less than expected – due to a major recession, for example. (Many people call only a DB plan a “pension” and refer to DC plans as “retirement accounts.”)

A third type of retirement plan is a “hybrid” plan that includes both DB and DC components.

Some East Lansing employees have defined benefit plans and others have hybrid plans, as we explain in a separate article.

 

This article is part of a larger investigation of East Lansing's pension plans; click here to read the lead article for that investigation.

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