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Defined Contribution Pensions Let Workers Choose Retirement Age
Daily Policy Digest

Economic Issues / Retirement Savings

Friday, April 05, 2002
In the last 20 years, defined benefit (DB) pensions -- which offer a predetermined payoff after a certain number of years of employment -- have become less common. Defined contribution (DC) plans -- such as 401(k) plans -- have become much more common. This has changed retirement incentives, say researchers, causing workers to delay retirement.

The value of many DB pension plans spikes at a particular age -- for example, the payoff may leap from 20 percent to 40 percent of pre-retirement income when the worker turns 60. Since working past age 60 adds little to future benefits, the worker has an incentive to retire then.

In contrast, the annuity value of a DC plan does not peak at any certain age, and a DC plan is portable -- allowing workers to change jobs without jeopardizing retirement income. Thus workers can choose their own retirement age based on their personal work preferences and desired retirement income.

Using data from the Health and Retirement Study, Leora Friedberg and Tony Webb (2000) estimated the likelihood of retirement under either pension type.

  • With a DB plan, more than 80 percent of workers would retire by age 65.
  • If those same workers had a DC pension, only about 60 percent would retire by age 65.
  • Overall, a worker with a DB plan retires 23 months earlier on average.
Of workers with some kind of pension coverage (which may include both types) the portion with a DC plan jumped from 60 percent in 1983 to 79 percent in 1995. Over that period, the number of workers with a DB plan fell from 85 percent to 40 percent.

Source: Abbigail J. Chiodo and Michael T. Owyang, " Putting Off Retirement: The Rise of the 401(k)," National Economic Trends, March 2002, Federal Reserve Bank of St. Louis; see also Leora Friedberg and Michael T. Owyang, "Not Your Father's Pension Plan: The Rise of 401k and Other Defined Contribution Plans," Federal Reserve Bank of St. Louis Review, January-February 2002.

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