Recently, some questions have been raised about which plan is better – the DB or the DC plan. There are a lot of factors to consider when making this determination, and the assumptions you use play a major role.
I’m going to look at one example. Let’s consider comparing a $20 DB plan and a $700 DC plan, both with an entitlement age of 60. We’ll assume a 5% annual return on the investments, and the RP 2014 Male mortality table. Let’s also assume that a volunteer stays active to earn 10 years of service credit, all in consecutive years and all earned before age 60.
Under the DB plan, the volunteer will have earned a $200 monthly benefit payable at age 60, regardless of the age when the 10 years of service is earned. Using the interest and mortality assumptions, the lump-sum present value of that $200 monthly benefit at age 60 is roughly $33,000.
Under the DC plan, when the service is earned plays an important role, because of the power of the compound interest. Here is the account balance at age 60 based on the age of the volunteer when the first of the 10 consecutive years of service credit is earned:
Age 20: $40,000, or 21% more than the DB plan
Age 25: $32,000, or about 3% less than the DB plan
Age 30: $25,000, or about 24% less than the DB plan
You can see as the age increases, the DB plan looks more and more valuable. So for a 20-year old, the DC plan is better. But beginning at age 25, the DB plan ends up working out better.
Of course, this does not take into consideration the fact that the $20 DB plan is likely to require contributions that could be 50% to 100% higher than the $700 DC plan. So it stands to reason a plan with a higher contribution would result in a higher ending benefit.
If we change the DB service award to $10 (cut it in half) the break-even age is around age 40.
There are many things to consider when comparing plans. Before making any decision, you should run an analysis with your actuary to evaluate which would be more beneficial for your membership.
Leave a Reply