Defined Benefit Plans Are Disappearing: Are Variable Annuities the Answer?

  • Peter A. Forsyth
Closeup photo of a calculator and a pen sitting on a sheet of grid paper.

Excerpt:

Traditionally, defined benefit (DB) plans have shielded retirees from the vagaries of the stock market. However, in an effort to de-risk, many private companies and public institutions are moving to defined contribution (DC) plans.

In a DC plan, the employee and employer make regular contributions into a retirement savings account. Usually, the employee decides (with a very limited choice) from a menu of investments. In fact, many of these plans simply ask the employee to select from {High,Medium,Low} risk investments, with few details provided about the actual investments.

During the DC pension accumulation phase, assets are usually managed professionally. However, the situation is often different, once the employee has retired. Upon retirement, the employee has to decide how to invest the amount accumulated in the pension savings account.

It is common wisdom that, over the long term, equities produce a higher rate of return than safe government bonds (the so-called equity risk premium). In most cases, it is necessary for a holder of a DC plan to invest in equities, in order to provide for a reasonable retirement income over 20-30 years.

However, since the retiree must withdraw from the investment account each year (in order to produce retirement income), the DC holder is exposed to significant order of return risk.