NCPA - National Center for Policy Analysis

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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