Among pension reformers there is a spirited ongoing debate regarding what might constitute a financially sustainable yet equitable solution. On one side there is a call to do away with defined benefits entirely, replacing them with defined contribution plans. The argument is compelling; with defined contribution plans, when the participant retires, they survive on the assets they have invested, and the employer has no contingent liability whatsoever. This is an appealing scenario to anyone who fully appreciates just how close our public sector pension funds are to financial collapse. But some of the ways defined benefits are characterized by their detractors are inaccurate.
For example, defined benefit plans are often referred to as “Ponzi schemes,” based on the premise that pension funds depend on new participants making contributions in order to fund the distributions being made to retirees. But the scam used by Ponzi (and Madoff) was to let new investors fund interest payments to existing investors, while all the while making the promise that existing investors had a claim on their original principal investment and could have it back at any time. Defined benefits do not offer a return of principal. If incoming contributions, plus interest earned on assets under management, offer sufficient extra capital to fund distributions, a pension fund is sustainable. A Ponzi scheme by definition is not sustainable.
Slightly more apt, but still inaccurate, is to characterize defined benefit plans as “Pyramid schemes,” based on the same premise – that their solvency depends on new participants [...] Read More