DB, DC Plans: Looking Beyond a Simple Comparison

By ASPPA Net Staff • August 21, 2015 • 0 Comments
A new study of DB and DC plans goes a little farther than just comparing them — suggesting that the best approach may be to move past the debate over which one is better.

In “Defined-Contribution Pensions Are Cost-Effective,” the Manhattan Institute looks at widely held perceptions about the relative advantages and disadvantages of DC and DB plans, including:

  • DB plans are structurally more cost-effective than DC plans.
  • State and local governments that offer DC plans are few and far between in part because of the support of unions, public retirement systems and consultants serving public sector DB plans.
  • DB plans yield higher investment returns and convert retirement funds into annuities.
The study looks at whether these perceptions are correct, and in the process reveals some interesting symmetry. Its findings include:

  • Empirical evidence does not support the notion that DB plans are structurally more cost-effective, nor more efficient, than DC plans.
  • DB and DC plans achieve similar investment returns. Between 1995 and 2012, average estimated 10-year performance differences between these types of plans — at the mean, median, 25th, and 75th percentiles — were less than 0.5%. In addition, the DB plans with the weakest performance did better than the DC plans with the weakest performance; however, the DC plans that performed the best exceeded the performance of the DB plans with the strongest record.
  • DC plans can — and do — offer annuities. Some private-sector DC plans provide annuities; in addition, most public-sector employers provide annuities at favorable prices under their DC plans.
  • Pension debt is a significant cost driver for DB plans. DC plan critics generally ignore these costs in their DC-DB plan comparisons.
  • Most current DC plans include plan features that automatically place participants on a secure retirement path, and can solve many of the political-economy and benefit-design problems associated with DB plans.
The study argues that workers’ retirement security would be better served by moving past the debate over which of these two kinds of plans are better. It suggest that the to that end, plans should:

  • incorporate adequate annual contribution/accrual rates;
  • offer access only to pooled, professionally managed and appropriately allocated investment options;
  • offer access to annuity options upon retirement; and
  • have well-designed defaults so that if workers do nothing, they will still be placed on the path to a secure retirement.