De-Bunking Myths About Defined Benefit Pension Plans
There a number of myths surrounding public pensions and defined contribution plans. In this report, Josh McGee uses empirical evidence to debunk common claims around the supposed structural efficiencies of traditional public pensions.
What are common claims about traditional defined benefit plans (DB) versus defined contribution plans (DC)? Critics often claim that DB plans achieve better investment returns at lower fees and are better for worker retirement security because DB plans offer annuities. But McGee argues that empirical evidence shows otherwise. Using data from the Department of Labor, McGee finds that:
- Investment returns are similar and not statistically different between DB and DC plans. Although DB plans may have had a small advantage in the 1990s in terms of investment returns, DC plans have improved dramatically. Today, there are no statistically significant differences in investment returns between DB and DC plans at the mean, median, or 25th and 75th percentiles.
- Moreover, investment returns are not equally distributed across workers. Younger workers face high attrition risk, or the risk that they will leave the profession before accruing adequate retirement savings. In a large majority of teacher plans (86 percent), teachers must stay for at least 10 years before earning pension benefits worth more than the value of their contributions plus the plan’s assumed investment rate of return. In almost half of teacher plans (40 percent), teachers need to stay in the same retirement system for more than 25 years before breaking even on their contributions.
- DC plan fees are distorted by small plans. Pension plan advocates often cite studies using the average fees of DB and DC plans. But plan size influences plan fees--smaller plans tend to pay a higher percentage in fees relative to assets--and DB plans are fewer in number and much bigger. Once controlling for plan size, the fee differences between the two types of plans go away.
- While most DC plans do not offer annuities, they are not inherently constrained from offering annuitized savings. DC plans can offer annuities, but many private sector DB plans avoid offering annuities because of federal regulations. Those regulations do not cover public-sector plans and thus do not present a barrier to public-sector employers offering annuities in their DC plans.
- Critics ignore the costs of massive pension debt in comparing DB and DC plans. Pension debt increases a DB plan’s annual costs substantially but are typically omitted from cost-effectiveness analyses comparing DB and DC plans.