Munnell Report Rattles DC vs. DB Plan Debate on Investing, Fees

A paper published in December by the Center for Retirement Research at Boston College questions the conventional wisdom that defined contribution participants are not good at investing their money and are paying higher fees than participants in a defined benefit plan resulting in lower returns.

“Are returns on defined contribution plans markedly lower than those on traditional defined benefit plans?” the authors asked.

It seems that yes, DB plans do show higher returns than DC plans, but not by much. Between 1990 and 2012, the report found, defined benefit plans did outperform defined contribution plans — by just 0.7%.

However, that difference persisted across plans of different sizes and allocations. “Since this differential remains even after controlling for size and asset allocation, the likely explanation is higher fees in defined contribution accounts,” according to the report.

The report uses data from the Department of Labor’s Form 550 between 1990 and 2012 to draw its conclusions. Authors Alicia Munnell, Peter Drucker and Jean-Pierre Aubry identified several factors that lead to higher returns in DB plans.

Plan size. In defined benefit plans, returns increased as the plan size did. DB plans with under $100 million in assets returned 6.5%, according to the analysis, jumping to 7.5% for the $100 million to $500 million plan size and increasing steadily to 8.3% for plans with over $5 billion.

For DC plans, there was a more pronounced increase between the smallest plan categories — 5.9% to 7.2% — but returns started to decrease after the $1 billion mark.

“In both cases, excluding plans with ‘less than $100 million” will produce higher returns,” according to the report. “Weighting by assets will also produce higher returns for both types of plans because it will de-emphasize the low returns earned by small plans.”

The smallest plans account for the greatest number of plans. Almost three-quarters of DB plans and the majority — 93.8% — of DC plans have less than $1 million in assets.

However, over 70% of the $2.4 trillion in DB plans are held in plans with over $1 billion in assets. The $3.1 trillion of DC assets are distributed more evenly across plan sizes, with the $1 billion to $5 billion category holding the greatest proportion of assets (26.5%).

Asset Allocation. The analysis also compared plans based on their concentration of higher risk investments like equities. Defined benefit plans have reduced their allocations to equities since 2000 “to match liabilities as companies have frozen their plans,” the report found. DC plans increased their allocation to equities through the mid 90s, and they’ve held steady at over 60% of the portfolio ever since.

“Although the asset allocation of the two types of plans differed significantly over the period 1990-2012, asset allocation would be expected to have only a modest effect on returns,” the authors wrote. “The reason is that the long-run (1926-2014) pattern, where risky equities significantly out-performed less risky long-term corporate bonds, has not held over the past two decades.”

Between 1990 and 2012, equities and corporate bonds had almost identical returns, the report found: 8.6% and 8.7%, respectively.