Sailors know that to maintain forward progress in a headwind they must trim their sails. Likewise, sailing into the worst economic headwinds since the 1930’s, defined benefit pension plans have trimmed their benefit accrual rates to maintain forward progress.

For example, in 2005, after the market downturns of 2000 and 2002, the Central Pension Fund reduced its benefit accrual rate for future service from 3.3% to 3.0%. Then, in 2009, after the worst market collapse since the Great Depression, the future accrual rate was reduced from 3.0% to 1.0%.

These responses to market events permit defined benefit plans to adjust to even the most severe economic reversals, while fully protecting the accrued benefits of plan participants. This protection doesn’t exist in the 401(k) world, where retirement account balances disappear when markets collapse.

To illustrate this advantage of defined benefit plans over 401(K)’s, consider the following example. Assume that two workers, Joe and Sam, commence their careers on the same day, work for 25 years, then retire. Assume they each work 2000 hours every year, and have contributions of $4 per hour made to their retirement plans for each hour worked. Each would accumulate $8,000 in contributions every year, producing total contributions of $200,000 at the end of 25 years.

Now assume that Joe’s contributions went to the Central Pension Fund, while Sam’s contributions went to a 401(k) plan. At the end of 25 years what benefit can each worker expect to receive? To determine this we make a couple more assumptions: First, we (conservatively) assume that Joe’s CPF benefit accrual rate for all 25 years is at the 1% accrual rate adopted in 2009; Second, we (generously) assume that for every one of the 25 years, Sam’s 401(k) account achieved an investment return of 7.75%; which is the historical rate of return achieved by the Central Pension Fund.

With these assumptions, Joe’s retirement benefit is easy to calculate: it is 1% per month of his CPF account balance of $200,000. This pays Joe a retirement benefit of $2,000 a month --- $24,000 a year --- for life.

Sam’s monthly benefit is a little more difficult to calculate, because Sam must determine how much he can afford to pay himself each month from his 401(k) account. Assuming he achieved a return of 7.75% each year, his $200,000 of contributions would have grown to an account balance of $585,777 at the time of his retirement.

Experts agree that, in retirement, 401(k) participants should not withdraw more than 4% annually from their account balance to assure that they will not outlive their money. An account balance of $585,777 paid out at 4% a year will provide Sam with a benefit of $1,953 a month.

Accordingly, using these assumptions, after a 25 year career the monthly benefits of Joe and Sam would be almost the same: $2,000 for Joe from CPF, compared to $1,953 for Sam from a 401(k).

But now let’s change just one assumption. Instead of Sam achieving a steady 7.75% return for all 25 years, let’s assume that he did so for the first 15 years, but that the final 10 years of Sam’s career were the last 10 years --- 2000 to 2010 --- and his 401(k) account achieved the actual returns of the U.S. investment markets during those years. Over that 10 year period the S&P 500 Stock Index had a return of negative .82%, while the U.S. Aggregate Bond Index had a positive return of 6.5% .

Using these actual investment returns, the benefit outcome for Sam changes remarkably for the worse:

• If his 401(k) was invested entirely in the S&P 500 Stock Index, Sam’s monthly benefit would be $815.
• If his 401(k) was invested entirely in the U.S. Aggregate Bond Index, Sam’s benefit would be $1,712 a month.
• If his 401(k) was evenly split between the S&P 500 Index and the Aggregate Bond Index, Sam’s benefit would be $1,248 a month.

As shown by this example, 401(k) benefits are dependent upon the vagaries of the investment markets, and especially what happens in those markets as retirement nears.

As also shown by this example, whether using the most rosy investment returns or the actual returns experienced over the last 10 years, CPF continues to provide superior retirement security for workers and their families.