DB AND DC – AKA APPLES AND ORANGES

Trying to compare the DB and DC plans is exactly like the old saying of trying to compare apples to oranges. Just like fruit, part of the decision making process in selecting which type of plan is better comes down to preference and taste – not something that can be analyzed. But, the analysis is worth doing. 

One of the ways you can approach understanding the two types of plans are considering when all participants are considered “equal” – meaning, when is the benefit they all earn during any given year from the sponsor the same.

In a defined benefit plan, they are all equal at the entitlement age. If a DB plan has an entitlement age of 60, and pays a $20 monthly service award for each year of service credit earned, then all participants that earn 50 points in 2018 are paid the same $20 monthly benefit when they turn age 60. (For now I’m going to conveniently ignore the fact that some firefighters could be over age 60.) If a 20 year old, 30 year old, 40 year old and 50 year old firefighter all earn 50 points in 2018, they all will be paid the $20 at age 60 – so they are all treated the same at age 60. Some have to wait longer than others to start collecting the benefit, but ultimately the terms of the plan say everyone will get paid the $20 per month beginning at age 60.

​In a defined contribution plan, all participants are equal at the time they are earned. So regardless of the entitlement age in a DC plan, every firefighter that earns service credit during a plan year receives the same contribution. Since programs do have an entitlement age and those contributions are not paid until each participant turns the entitlement age, then most certainly the amount each participant is actually paid will be different. The amount will depend on what rate of interest is earned on those contributions.

In summary, DB plan participants earn equivalent benefits at the entitlement age, while DC plan participants earn equivalent benefits at the time the benefits are earned. In order to compare the two plans, we have to decide at what point should the comparison be made – at the current age or at the entitlement age. In order to avoid heavy-duty actuarial math, we will make the comparison at entitlement age in a future post.