Central Pension Fund

Study Quantifies Defined Benefit Advantage

Over the last decade as more employers have either terminated their defined benefit pension plans, or converted them to defined contribution plans, the American public has become increasingly concerned with retirement security.

Because defined contribution plans shift from employers to employees the longevity risk, that is, the risk that the employees might outlive their benefits, employers and their high-paid consultants have tried to convince workers that defined contribution plans are superior to defined benefit plans. This sales job is usually along the lines of: “it’s your money, you should determine how to invest it and how you want to spend it.”

Likewise, because defined contribution plans offer Wall Street the opportunity to charge higher fees, the big investment brokerage firms have also spent millions promoting defined contribution plans over defined benefit plans. It’s the same reason they have promoted privatizing the Social Security system --- higher profits.

Until now, it has been difficult to respond to these sales jobs with hard figures, because quantification is very difficult. Now, however, such quantification has taken place, and it proves what everyone knew through common sense: substituting risky defined contribution plans for defined benefit plans will cost workers a lot of money when they reach retirement.

In May of this year the Employee Benefits Research Institute (EBRI), a highly regarded Washington, D.C. think tank, issued the results of an extensive statistical analysis of the future of retirement security.

The researchers identified the current level of assets in defined benefit plans and defined contribution plans in the United States. Generally, defined benefit plans provide for the payment of benefits in regular monthly payments for the participant’s lifetime, while defined contribution plans provide for a single lump sum payment of the participant’s account balance on the date of retirement.

For the first time ever, the EBRI research has quantified exactly how much more valuable monthly annuity payments for life are than receiving the same amount of money in a single lump sum payment.

The study found that if all defined benefit pension plans that currently pay benefits in a monthly annuity were to convert to paying only in a lump sum, on average, participants would need to begin saving an additional 14% a year to maintain the same retirement security.

On the other hand, the study found that if all defined contribution plans paying benefits as lump sums were converted to paying monthly benefits for life, participants would be able to reduce their future savings for retirement by 30% a year and still maintain the same level of retirement security.

This large difference in the outcomes between receiving monthly payments versus a single lump sum payment is attributable solely to longevity risk --- the risk that you will outlive your benefits. Obviously, in defined benefit plans the longevity risk is zero. You cannot outlive monthly benefits for life.

But you can outlive a lump sum payment. In fact it’s just about impossible to assure that your life and your money both last the same amount of time. One always outlives the other. By putting a price on longevity risk, the Employee Benefits Research Institute has provided a quantitative measure of the advantage of defined benefit pensions over defined contribution pensions --- 30%.

Originally published in the International Operating Engineer