Critics of defined contribution plans argue that defined benefit plans are more cost-effective because the latter deliver higher investment returns and convert retirement savings into annuities. But a new paper subjects those assertions to empirical scrutiny.
The report, by Josh B. McGee, a senior fellow at the Manhattan Institute and vice president of public accountability at the Laura and John Arnold Foundation, notes that the relative merits of DC plans and DB plans have long been debated, and that when state and local governments have considered adopting a DC plan for new employees, they have encountered significant opposition from organized labor, managers of public retirement systems and what he refers to as “the cottage industry” of consultants that supports public DB plans.
Among the report’s key findings:
- DB plans are not structurally more cost-effective than DC plans. The author notes that claims of the superior efficiency of DB plans, which he says are underpinned by false assumptions and a neglect of pension debt as a significant cost drive, are not supported by empirical evidence.
- DC plans achieve similar investment returns. The report notes that between 1995 and 2012, average estimated 10-year performance differences between DB and DC plans — at the mean, median, 25th and 75th percentiles — were less than half a percentage point and, according to the author, were generally not statistically significant. In sum, bottom-performing DB plans outperformed bottom-performing DC plans; and top-performing DC plans outperformed top-performing DB plans. Since 2000, performance differences have further narrowed, according to the report.
- DC plans can — and do — offer annuities, though perhaps not as widely as do DB plans. The report’s author lays the limited availability of annuities among private-sector DC plans at the fee of “misguided federal regulation,” which he says discourages their provision.
- Pension debt is a significant cost driver for DB plans, and one generally ignored in DB/DC plan comparisons. As an example, he notes that carrying a pension debt equal to 10% of liabilities would increase annual cost as a percentage of payroll by around 70%, and that carrying a debt equal to 20% of liabilities would increase annual cost by around 140%.
- DC plans are a good option for providing retirement security. The paper explains how most current DC plans include a number of plan features — including well-designed, diversified, professionally managed investment products — that automatically place participants on a secure retirement path. He goes on to explain that DC plans can also solve many of the political-economy and benefit-design problems associated with DB plans.
