A study that compared defined benefit retirement plans -- old-fashioned pensions -- with defined contribution plans -- 401(k)s and 403(b)s -- in the public sector, concluded that not only do most participants prefer defined benefit plans, but also, they are more efficient and may in the end cost taxpayers less.
The study by actuarial firm Milliman Inc. for the National Institute on Retirement Security looks at expenses and investment income from defined contribution plans and concludes what nearly all of us with 401(k) or 403(b) plans probably already know from our retirement planning -- expenses are high and returns are low.
Researchers found that that asset management fees average just 0.25 percent of plan assets for public sector defined benefit pension plans. By comparison, asset management fees for private sector 401(k) or 403(b) plans range from 0.60 percent to 1.70 percent of assets. If you do the math, you can see that someone in a 401(k) or 403(b) plan could have as much as a 1.45 percent anchor around their retirement savings compared to someone with a public sector defined benefit plan. Over 40 years, the study says, a 1 percent difference in fees compounds into a 24 percent reduction in the value of assets. Wow!
If that's not bad enough, the study points to a calculation from benefits consultancy Towers Watson that professionally managed defined benefit pension plans earn 1.80 percent more on average annually than personally managed defined contribution plans. Milliman describes the experience of the State of Nebraska employees where some workers had a defined benefit plan, but other ones were offered only a defined contribution plan.
Over the 20 years, the average return in the defined benefit plan was 11 percent and the average return in the defined contribution plans was between 6 percent and 7 percent. As a result of these lower returns, employees were only replacing 30 percent of their pre-retirement income rather than the originally projected 50 percent to 60 percent.
Finally, the study examines the experience of some selected public entities that have frozen or otherwise cut back their defined benefit option for some or all employees and found that when a public entity switches to a defined contribution plan, the move doesn't close any funding shortfalls.
That's because a lot of promised payout from defined benefit plans is based on pooling continuing contributions. Freezing the plan could mean that as participants retire and live longer and longer, the money available to pay their pensions isn't replenished and taxpayers may have to ante up just to cover what's due from the frozen plans.
Bring back old-fashioned pension plans.