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A defined benefit retirement plan is one that promises a specific retirement benefit --- $20 per month, say, for each year of employment. Someone who works for the same company for thirty years would get a retirement benefit of $600 per month that would start when they reached age 65. Another typical benefit is to receive half your average monthly salary based on the average monthly salary for the last five years of employment. These plans typically have vesting schedules that require that you work for the company for several years before you earn a right to your full scheduled benefit. To fund these promises, companies deposit money into a pension account where it accumulates tax-free like 401(k) money. The tough question for companies is always, "How much should we deposit to meet that future obligation?" To best understand how such a plan works, we look at the start of the benefit payments. These payments are funded by something called an annuity. An annuity is a financial product that guarantees an amount of income for the rest of one's life. While life insurance offers protection if you die too soon, an annuity protects you if you live too long. An annuity guaranteeing one dollar of monthly income ($12 per year) for the rest of your life costs about $135. If you live to 105, it is a terrific deal. If you die next month, you just blew $134, and you've helped to support the people who lived long lives. Defined Benefit plans don't actually buy annuities, but they use the concept to determine how much their retirement obligation is expected to cost. Designing, operating and computing these complex promises is called "actuarial science" and the practitioners are, of course, actuaries. The cost of the future promise is influenced by many events over time. The turnover of employees, for starters, determines how many people actually get to the finish line with any meaningful benefit. When the average length of employment is only about seven years, the number of people benefiting is not as large as we would think. Future salary increases must also be taken into consideration when determining what the ultimate funding requirement might be. Defined benefit plans, then, require enough deposits and investment earnings to be able to buy that $135 annuity to support each dollar of monthly income that they have promised to a retiring employee. By comparison, a 401(k) plan offers no promises. Whatever you see at retirement is what you will get. While defined benefit plans offer security and a predictable benefit guaranteed by both the employer and the U.S. Government, they also can wreak havoc with corporate cash flow. Thanks to very fortunate stock market performance throughout the nineties, many pension plans required little or no contributions from employers. In many cases, the excess earnings from the pension plans were credited back to the sponsoring companies where they appeared as earnings on the income statement. Now, it is a far different story. Warren Buffett, in FORTUNE's latest cover article, warns of the emerging liability that these plans represent and the impact that funding obligations will have on corporate earnings. This is just the beginning of the problem. The Pension Benefit Guarantee Corporation (PBGC) is a government agency that guarantees with government money any pension shortfalls in companies that are bankrupt. Remember the $6 billion bailout loan we taxpayers made to Chrysler in the Lee Iacocca era? What escaped notice at the time was that the Chrysler pension plan was exactly $6 billion under water. If we hadn't made the loan, Chrysler would have gone under and we would have had to spend $6 billion of the PBGC fund. Another abuse
of these plans occurred during the merger and acquisition heyday
of the 1980's. Many plans had excess funding which meant they
had more money than was needed to fund future benefits. Corporate
raiders were able to "repatriate" and use these excess funds to
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