We know that America has widening income inequality. The rich are getting richer, and wages have been stagnant for everybody else.
We also know that fewer Americans have access to defined benefit pension plans, putting more of the burden of saving for retirement on individual employees.
Are these two trends compounding each other? The short the answer is no, this is not happening. As I argue below, this is mainly due to our investments in progressive programs like Social Security and Medicare. The transition from defined benefit to defined contribution plans has been going on in the background, and it may seem at first blush like this transition could increase inequality, but that would be a misread of how the plans work.
First, consider the logic. Both defined benefit and defined contribution plans award benefits as a percentage of salary. Consider two workers in the same firm, a low-paid manual labor and a higher-paid executive. If, over time, the salary of the executive rises faster than that of the manual laborer, their retirement wealth will also become skewed as well. But crucially, this would happen in direct proportion to the change in salaries, regardless of plan type. Under either a defined benefit or a defined contribution plan, the executive gets a higher retirement benefit in direct relation to his or her higher salary.
If anything, the above example might be under-selling things a bit, because it assumes both types of workers stay with their company for the same length of time. Traditional defined benefit pension plans reward both high salaries AND long tenures, and we know that higher-paid executives have much more employment stability than lower-paid manual laborers. In this scenario, the manual laborer would be better off in a front-loaded defined contribution plan than a back-loaded pension plan.
The politics of this are confusing, since liberals tend to be the ones defending defined benefit pension plans, but there’s nothing special about them in this regard. Traditional pension plans are not inherently progressive. In fact, so-called “teacher” pension plans tend to reward higher-paid school administrators over more transient, lower-paid teachers.
Ok, enough with the theory, what do the data show? Retirement wealth is a function of participation and contribution rates. Once you combine both types of plans, workers are no more or less likely today to participate in a retirement plan than they were 30 years ago (see Figure 20 here), and total retirement savings has also kept pace. That is, the type of retirement plan has not dramatically changed our collective retirement preparation.
In terms of results for individuals, earlier this year I wrote about a paper from Adam Bee and Joshua Mitchell from the U.S. Census Bureau. Among Americans age 65 and older at the 25th percentile in terms of income, they found income gains of 31 percent from 1990 to 2012. For those at the 75th percentile, the gains were similar, at 32 percent. They also found that poverty rates among those 65 and older declined from 9.7 to 6.7 percent. To be sure, these stats do not prove that there is no inequality in retirement wealth, only that we’ve provided retirees with some buffer against it.
Namely, Americans over age 65 have a giant social safety net through Medicare and Social Security. To show just how important Social Security is, consider the chart below, from the Federal Reserve. The first two columns show that the top 5 percent of households have about 13 times the income as the bottom 50 percent of households, and about 110 times (!) the retirement wealth in the form of DB and DC retirement plans. That is, wealthier people have much more in the way of retirement assets than lower-income people. This has always been true, and income inequality is making these trends worse. But look at the last column, which compares total retirement wealth (including Social Security) with income while working. As a ratio of retirement wealth to wealth while working, the bottom 95 percent is doing ok, mainly because of Social Security.
Unlike our other forms of retirement savings, Social Security is explicitly designed to be progressive, and it is effectively providing a floor of retirement benefits and keeping retirees out of poverty. It’s possible that defined benefit or defined contribution plans could be designed more progressively. Defined benefit plans could provide a floor of benefits to all workers, for example, or award proportionately higher benefits for lower-paid workers. Defined contribution plans could be framed in terms of level-dollar amounts for each worker, as opposed to a uniform percentage rate which benefit higher-paid workers more.
But these elements are rare, and in fact the opposite is more common, where stable workers get extra rewards for their stability and transient workers lose out. In the teacher space, many states give extra perks to teachers or administrators who reach thresholds like 20 or 25 years of service. Those are another way states have made their teacher pension plans regressive, not progressive, and they're not even effective as retention tools. Worse, more than 1 million teachers don’t have access to Social Security, leaving them particularly vulnerable to poorly designed retirement plans.
All told, fewer older Americans have defined benefit pension wealth, and the poverty rate among elderly Americans has fallen dramatically. Both things can be true at once.