The National Institute of Retirement Security released a study on Thursday that found defined-benefit plans are strongly preferred over defined-contribution plans in the public sector.
The study, “Decisions, Decisions: Retirement Plan Choices for Public Employees and Employers,” analyzed seven retirement systems in six states that offer a choice between pension-style plans and 401(k)s. It found that pension-style plans were selected between 75% and 98% of the time.
The report notes, though, that much like high 401(k) participation rates among private sector workers due to automatic enrollment, many public sector employees are defaulted into their employers’ pension plan. “The overwhelmingly high take-up rates, then, could be at least partially driven by inertia on the part of employees, a large number of whom do not make an affirmative choice,” according to the report.
The public sector hasn’t seen the same level of defection from pension-style plans that the private sector has. Private sector DB coverage fell from 76% of full-time employees in 1986 to 24% in 2008, while participation in DB plans among public employees only dropped from 93% of full-time employees in 1987 to 88% in 2008, according to the Bureau of Labor Statistics.
The report found pension-style plans typically earn higher investment returns than 401(k)s because assets are pooled and professionally managed. Research from Boston College found that asset management fees in pension plans average 0.25% of assets, compared with fees that range between 0.6% and 1.7% in 401(k) plans.
Pension plans also tend to use broadly diversified portfolios and managers who follow a long-term investment strategy. Employees in 401(k)s, though, are less likely to make good investment decisions on their own, say the study’s authors.
States that consider moving from a defined-benefit plan to a defined-contribution plan in order to address unfunded pension liabilities find that such a shift does not close funding shortfalls and can increase retirement costs, according to the study.
Defined-contribution plans do not have the same economic efficiencies that defined-benefit plans do, the report found. Pension plans are more cost efficient than 401(k)s due to higher investment returns and longevity risk pooling, according to NIRS. Furthermore, maintaining two retirement plans is more expensive than a single plan. Typically, employers aren’t able to move their DB plan participants out of their current plan into a new DC plan, forcing them to maintain two plans for some period of time. Phasing out a DB plan could take “many decades,” according to the report, as its participants “complete their careers, retire and ultimately die.”
While the study only analyzed plans in Colorado, Florida, Montana, North Dakota, Ohio and South Carolina, Mark Olleman, consulting actuary and principal with Milliman Inc. and report co-author, noted that experiences in Nebraska and West Virginia were also helpful to the research.
“Both states chose to put new hires in a DC plan, and then later changed to DB,” Olleman said in a statement. “Nebraska offered some employees hired between 1964 and 2003 only a DC plan, but also maintained a DB plan for other employees. Over 20 years, the average investment return in the DB plan was 11%, and the average return in the DC plans was between 6% and 7%.”
Closing teachers’ defined-benefit plan to new hires in West Virginia in the early ‘90s did not solve the state’s funding problem, Olleman continued, and those who had only the defined-contribution plan found it difficult to retire.
“West Virginia performed a study, found a given level of benefits could be funded for a lower cost through a DB plan, and put all teachers hired after July 1, 2005, in the DB plan as a cost-saving measure,” he said. “Both Nebraska and West Virginia found a DC plan did not achieve their goals and changed from DC to DB.”
Ilana Boivie, report co-author and economist with the National Institute on Retirement Security, noted that the report’s findings are consistent with an earlier opinion poll by NIRS that found 83% of Americans believe those with pensions are more likely to have a secure retirement.
“Employers understand that pensions remain the most cost-effective way to fund a retirement benefit, and that switching from pensions to individual accounts can drive up costs for taxpayers,” Boivie said. “These economic facts coupled with strong employee preferences for pensions suggests that public employers are unlikely to mimic the trend away from pensions that has occurred in the private sector.”