Long time readers of Defined Benefit know that 401(k)-style defined contribution plans have largely failed working families. Defined contribution plans are a poor substitute for defined benefit pension plans and as the private sector has shifted from pensions to 401(k)s, working families have fallen behind. More and more research is emerging that demonstrates the inadequacy of defined contribution plans. Earlier this year, the Center for Retirement Research (CRR) released a new issue brief that reveals the cold, hard facts.
CRR’s issue brief examines how the shift from pensions to 401(k)s affected retirement wealth and income in the period from 1992-2010. The researchers found that while total retirement wealth from employer plans was flat, the amount of retirement income generated by that wealth declined as did the overall replacement rate of pre-retirement income. Furthermore, retirement wealth is becoming increasingly skewed toward the top of the income spectrum and overall participation in employer-sponsored plans has declined.
There are several important takeaways from this report. First, overall participation in employer-sponsored retirement plans has declined from 68 percent in 1992 to 63 percent in 2010. This fact alone should be very concerning. Fewer people saving for retirement means fewer people will be prepared to retire with dignity when that time comes. The shift to defined contribution plans undoubtedly plays a role in this decline. Almost all participants in traditional pension plans are automatically enrolled in their plan and begin contributing from their very first paycheck. Many defined contribution plans do NOT have auto-enrollment features; therefore, workers have to actively choose to participate. This alone is enough to lower the overall participation rate.
Second, the percentage of employees participating only in a defined benefit pension plan has declined sharply from 44 percent in 1992 to 20 percent in 2010. This is unfortunate because, as the CRR researchers calculate, defined benefit plans provide higher levels of retirement wealth than defined contribution plans. Those higher levels of wealth then translate into higher levels of retirement income. Again, across the entire time period covered in the report, defined benefit pension plans generated higher levels of both retirement wealth and income than 401(k)-style defined contribution plans.
Third, the shift from defined benefit plans to defined contribution plans has skewed retirement wealth toward the higher end of the education and income spectrum. The CRR researchers use educational attainment as a proxy for income. For those in the highest quartile of educational attainment, they held 52 percent of defined contribution wealth, compared to only 35 percent of defined benefit wealth. We’ve discussed before how defined contribution plans favor the wealthy and this analysis provides further evidence of that.
So what does all of this mean? It means that the increasing prevalence of 401(k)-style defined contribution plans has weakened the retirement security of working families. Defined contribution plans are less efficient than defined benefit pensions. It is also much more difficult for retirees to spread out their retirement wealth with defined contribution plans because of a lack of good annuity options in the open market. Defined benefit plans are vastly superior in this respect because defined benefit pensions calculate a benefit amount that is paid monthly and guaranteed for life.
This report should serve as further warning to those pushing for states and cities to abandon defined benefit pensions and force workers into risky and unreliable defined contribution plans.