The “tax extenders” bill, which yesterday I relabeled The Hypocrisy Act of 2010, contains some little-discussed provisions that would allow certain firms to further underfund their employee pensions. Advocates for the legislation promote this as a virtue, continuing a longstanding bipartisan trend of Congress rewarding bad pension behavior by both management and labor bosses in firms with a certain type of pension plan. These provisions are irresponsible and should be removed from the bill.
I’m going to use this as an opportunity to provide a crash course in a few aspects of pension policy. Let’s begin with some background on defined contribution and defined benefit pension plans.
In a defined contribution (DC) pension plan, an employer commits to contributing specific dollar amounts into an employee’s pension account. The employee then makes investment decisions for the funds in his account. The employee has both the upside and downside investment risk: if he invests well, he will have more for retirement. If he invests poorly, he will have less. The employer usually contracts out to a private investment firm (like Fidelity) for the account and investment management.
In a defined benefit (DB) pension plan, an employer commits to pay the employee a specific benefit amount at retirement. The employer owns both the upside and downside investment risk.
If a worker is risk averse toward investment, then the advantage goes to the DB plan. If he thinks he can manage his investments better than his employer can, then the advantage goes to the DC plan. Many workers are risk averse with their retirement planning. Also, if you hate private investment firms (as some on the left do), then you probably don’t like that aspect of a DC plan.