Defined Contribution Pensions Are Cost-Effective
August 17, 2015
Many public sector employers have considered placing new employees in a defined contribution (DC) plan. In a typical DC plan, workers are promised a certain level of annual employer contributions to individual accounts. But only two states and a handful of cities currently use a DC plan for new employees. When state and local governments consider adopting DC plans for new employees, they encounter opposition from organized labor, current public-retirement system managers, and consultants that support public defined benefit (DB) plans. In a typical DB plan, workers are promised a monthly retirement benefit based on salary, age and years of service.
A study from the Manhattan Institute examined the effectiveness of both the defined contribution retirement (DC) plans and defined benefit retirement (DB) plans. Key findings included:
- DB plans are not structurally more cost-effective than DC plans. Claims of the superior efficiency of DB plans are not supported by empirical evidence.
- DC plans achieve similar investment returns. Between 1995 and 2012, average estimated ten-year performance differences between DB and DC plans -- at the mean, median, 25th, and 75th percentiles -- were less than half a percentage point and were generally not statistically significant.
- DC plans can -- and do -- offer annuities. The limited availability of annuities among private-sector DC plans is largely the result of misguided federal regulation.
- Pension debt is a significant cost driver for DB plans. DC plan critics generally ignore the cost of carrying pension debt -- one of DB plans' largest cost drivers -- in comparisons.
- DC plans are a good option for providing retirement security. Most current DC plans include a number features -- including well-designed, diversified, professionally managed investment products.
Source: Josh McGee, "Defined Contribution Pensions Are Cost-Effective," Manhattan Institute, August 2015.
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