Defined Benefit pension plans are fixed income specialists dream.

Every plan has it’s own set of characteristics, but they all share something in common, you get nothing now and a stream of defined benefits (amount of money) that are fixed in the future.

From the beneficiary standpoint, if you are no longer working for your old employer and have been allowed to leave your cash in their plan, you constantly (until you reach a certain age) are facing a single question. Do I cash out now or leave it in the plan? Generally, after a certain age the choice is made for you. You need to stay in the plan and you will start receiving your monthly installments.

Here’s what I think the main drivers of that decision should be:

1. Do you think of going back to your old employer? If you do, it might be beneficial to leave your DB plan intact as it can benefit if you go back. But that’s not necessarily a given, it depends on the plan specifics, the length of time and the salary you have earned in the past vs the salary you will earn in the future.

2. Where are interest rates going to go? Some defined benefit plans are effectively cash accounts invested in long term bonds from the beneficiary standpoint. The convexity of a pension plan is often significant.

3. How long will you live? If you think you will live forever, leave your cash in your defined benefit plan. According to current life expectancy tables, the odds are that you will live to 81, a bit less if you are a man, a bit more if you are a woman but that is about it. There are generally penalties associated to dying before 65 and the payout schedule generally varies greatly if someone survive (if you have a beneficiary). In the event where there is no beneficiary the cash flow stream ends. All of this matters in making a decision as to when to stay and when to fold in the Defined Benefit pension plan game.

Here is an article on life expectancy.

Measuring death probability before a certain age can be akin to measuring default probabilities in corporate America. Low probability, high negative payout for the beneficiary. It is a social tragedy and often very sad for the workplace but it is also an (unlikely) economic windfall for the pension plan operator.

Measuring death probability after a certain age becomes a stopping time problem (at least until now). Everyone dies eventually but hopefully we die old and healthy. The longer we live the more we benefit from our contributions.

In conclusion, you might think you are just not going to think about it, that the money is out of your hands, but in fact as far as I’m concerned what you are doing in many cases is just leaving your money in a long dated life contingent risky bond.

I will eventually cover Defined Benefit from the plan operator perspective, but it will be another day.