Ever wonder what would happen in a world without defined contribution plans? Or a world in which everyone had one? A new study by the Employee Benefit Research Institute examines what impact these scenarios would have on retirement income adequacy.
In recent years, various policy proposals have called into question the value of existing DC plans, but the suggested alternatives did not provide a detailed analysis of the impact of terminating DC plans on retirement income adequacy for American households – until now, that is.
EBRI has provided some tangential evidence with respect to the potential impact previously. In 2014, it provided simulation analysis of the serious error introduced by models that ignored future contribution activity from DC plans. And in 2017, EBRI simulations showed that, if there were no employer-sponsored retirement plans (DB as well as DC) and individuals were assumed to behave in the manner observed for those with no access to such plans, the aggregate retirement deficits would jump from $4.13 trillion to $7.05 trillion – an increase of 71%.
In contrast, using its Retirement Security Projection Model, EBRI explores what the effect on retirement income adequacy would be for various cohorts of American households if DC retirement plans are either completely eliminated (worst-case scenario) or made universally available (best-case scenario).
In “Alternative Realities: The Impact of Extreme Changes in Defined Contribution Plans on Retirement Income Adequacy in America,” EBRI finds that younger workers and single women’s prospects for requirement income adequacy would be the most affected by the presence or absence of DC plans.
EBRI notes that the results are significantly greater for younger cohorts, since they would experience the best or worst case for a longer period. In the scenario in which DC plans were eliminated, the retirement deficits of those aged 35-39 were projected to increase 23% from $49,182 to $60,253.
In comparison, the deficits of those ages 40–44 would increase 18%, while deficits of those ages 45-49 would increase by 13%. For households above age 50, the average deficits would increase by less than 10%.
In reviewing the best-case scenario of universal coverage, average retirement deficits would decrease 24% from $49,182 to $37,506 for the youngest age cohort. Not surprisingly, older cohorts would experience less of an impact. Deficits of those ages 40-44 are projected to decrease 19%, while deficits of those ages 45-49 and ages 50-54 would decrease 16% and 12%, respectively. For households above age 55, the average deficit would decrease by less than 10%.
The results also show that under the universal DC plan scenario, for those in the youngest cohort, the decrease in average deficits is significantly larger for single females at $13,285 and single males at $11,690, versus other marital cohorts. When looking at older ages, EBRI notes that the impact of universal DC plans for single males is similar to that found for widows, but a universal DC plan scenario would be most beneficial to single females.
Jack VanDerhei, EBRI Research Director and author of the study, emphasizes that the study is an important step in analyzing the pivotal role DC plans play in retirement security. “In recent years there have been a number of policy proposals that call into question the value of existing defined contribution plans. However, the suggested alternatives have not included a detailed analysis of the impact of terminating DC plans on retirement income adequacy for American households,” VanDerhei explains.
The report notes that although the study was devoted specifically to analyzing the present values of retirement deficits and that this output metric may be preferred for public policy analysis focusing on retirement income adequacy, it actually masks much of the impact of the two scenarios analyzed.
For example, when evaluating the impact of a universal DC system, to the extent that a household was not simulated to run short of money in retirement under the baseline, increasing their access to an employer-sponsored defined contribution plan will not change their simulated retirement deficit (it will remain zero).
EBRI notes that it has developed alternative output metrics during its analysis of Rothification proposals in 2017 and will apply them to these scenarios in a future study.