“A new study finds that public sector employees with retirement plan choice overwhelmingly choose defined benefit (DB) pension plans over 401(k)-type defined contribution (DC) individual accounts”

WASHINGTON, D.C., August 23, 2017 - A new study finds that public sector employees with retirement plan choice overwhelmingly choose defined benefit (DB) pension plans over 401(k)-type defined contribution (DC) individual accounts.

Among the eight states studied that offer employees such a choice, the DB pension take-up rates in 2015 were 80 percent or higher in six states. Two of the plans studied had pension take-up rates higher than 95 percent, while Florida and Michigan had take-up rates of 76 percent and 75 percent, respectively.

Importantly, the research finds that even when the retirement plan default option favors a DC plan, most employees still select a DB pension plan. For example, in Washington the default retirement plan is a combination DB/DC plan. Employees must affirmatively act to elect to participate in the DB pension plan instead, and they do. The majority of newly-hired employees - six out of every ten new hires - actively choose a pension plan.

These findings are contained in a new study, Decisions, Decisions" An Update on Retirement Plan Choices for Public Employees and Employers, available here. The research is co-authored by Jennifer Brown, manager of research for the National Institute on Retirement Security (NIRS) and Matt Larrabee, principal and consulting actuary with Milliman. 

"When employees have a choice, pensions continue to win in a landslide," says report co-author Jennifer Brown. "These findings indicate that public employees highly value their pension benefits, which is consistent with NIRS' polling that finds Americans strongly support pensions for providing economic security in retirement. Notably, our polling also indicates that public employees strongly agree that all Americans should have a pension."

"Our findings also suggest that the public sector is unlikely to mimic the trend away from pensions as seen in the private sector for two reasons. First, there is strong employee support for pensions. Second, DB pensions remain the most cost-effective way for public employers to provide a modest and secure retirement benefit for employees who typically earn less than comparable private sector employees," Brown explained.

Some states started to offer public employees a choice between DB pension plan or an individual DC account for their primary retirement plan as far back as 18 years ago. Today, seven statewide pension systems give new hires the choice between participating in a DB pension or a DC-only plan - in Colorado, Florida, Montana, North Dakota, Ohio (two systems) and South Carolina. In two states - Utah and Michigan - some or all employees have a choice between a combined DB/DC plan and a DC only plan. Washington offers a choice between a DB pension and a combined DB/DC plan.

Across the board, the experience of these systems indicates that public employees overwhelmingly choose the DB plan. In 2015, North Dakota's DB plan had the highest take up rate at 98 percent; the lowest DB take up rate was in Michigan, which still saw 75 percent of employees opting for the DB pension. As such, the percentage of new employees electing DC plans currently ranged from two percent in North Dakota to 25 percent in Michigan.

Over the last decade, employee election patterns remained consistent for each state. However, a noticeable spike in employees choosing the pension occurred after the 2008- 2009 stock market collapse… The research also indicates that employees directing their own investments typically tend to earn lower investment returns than that of state pension plans.

The investment advantage in public DB pensions can be attributed to three factors: lower expenses, professional asset management and an optimal investment allocation used by the DB plan over decades. DB pension plans also benefit from longevity risk pooling.

Also, the research examines the issue of states eliminating DB pensions and moving new hires into DC accounts in the hopes of lowering costs or addressing funding shortfalls often caused by states skipping their full actuarial contributions. But, the experience of states shows that such a change has the opposite impact with a DB to DC switch increasing retirement costs for employers and taxpayers in the immediate future.

The new research is an update to a 2011 study with similar findings. To conduct the study, NIRS and Milliman requested information directly from the retirement systems that allow new hires to choose between DB, DC, and combination plans. These systems provided statistics on members that have selected each option. The authors also requested other important provisions relating to benefits and contributions. This primary source material provides a valuable insight into what really happens when public employees are allowed to choose between DB and DC.

Download the full study here.

The National Institute on Retirement Security is a non-profit, non-partisan organization established to contribute to informed policy making by fostering a deep understanding of the value of retirement security to employees, employers and the economy as a whole. Located in Washington, D.C., NIRS' diverse membership includes financial services firms, employee benefit plans, trade associations, and other retirement service providers. 

More information is available at www.nirsonline.org. Follow NIRS on Twitter @nirsonline. Contact: Kelly Kenneally | kkenneally@nirsonline.org | 202.457.8190

Commentary:

What is the difference between a Defined-Contribution Savings Plan and a Defined-Benefit Pension Plan? (Posted on this blog Sept. 30, 2011; June 10, 2013; Jan. 4, 2015; March 17, 2017):

A Defined-Contribution Savings Plan:

1) A defined-contribution savings plan (401(k), 403(b), 457) was not initially created as a retirement vehicle but rather as a supplementary savings account;
2) A defined-contribution savings plan shifts all the responsibilities and all of the risk from the employer to you; thus, your benefit is not guaranteed for life;
3)  Your benefit ceases when your account is exhausted;
4) There are no survivor or disability benefits and guarantees;
5)  Your benefit is based upon individual investment earnings;
6)  You assume all funding, investment fees, and inflationary and longevity risks;
7)  A defined-contribution savings plan does not have the pooled investments, professional asset managers, and shared administrative costs that a defined-benefit pension plan provides;
8) Though you bear no portability risks, accounts are not always rolled over when you change jobs;
9) Changeover costs to this plan could be significant;
10) Your employer (state) will have to bear the administrative costs of both defined-benefit pension and defined-contribution savings plans when you switch over;
11) “Payments to amortize unfunded liabilities for the defined-benefit pension plan may be accelerated” (National Institute on Retirement Security (NIRS, 2011);
12) The Governmental Accounting Standards Board “requires [an] acceleration of unfunded liability payments when the defined-benefit pension plan is closed to be recognized on financial statements” (NIRS, 2011);
13) “No unfunded obligations [liabilities] for existing members are reduced when new members go into a defined-contribution savings plan” (NIRS, 2011);
14) “The loss of new members makes it difficult to finance the unfunded obligations of the defined-benefit pension plan” (NIRS, 2011);
15) The State of Illinois will not save money. Most of the State’s obligation to TRS is for contributions not paid during the past several decades; therefore, the deferred cost of underfunding cannot be eliminated by switching to a defined-contribution savings plan;
16) Shifting to a defined-contribution savings plan can raise annual costs by making it more difficult for Illinois to pay down existing liabilities. The plan will include fewer employees and fewer contributions going forward;
17) Even with a defined-contribution savings plan option, states and localities are still left to deal with past underfunding;
18) There is a several trillion dollar deficit between what 401(k) account holders should have and what they actually have.

A Defined-Benefit Pension Plan:

1)  You cannot outlive your benefit;
2) Your defined-benefit pension plan is more cost efficient than the defined-contribution savings plan;
3)  Your defined-benefit pension plan offers predictable, guaranteed monthly benefits for life;
4)  Funds are invested by professional asset managers in a diversified portfolio that follows long-term investment strategies;
5)  The large-pooled assets reduce asset management and miscellaneous fees;
6)  Your defined-benefit pension plan provides spousal (survivor) financial benefits;
7)  Your defined-benefit pension plan provides disability benefits;
8)  The state is responsible for funding, investment, inflationary and longevity risks;
9)  Because you are not affected by Market volatility, your defined-benefit pension plan is a more effective protection than the defined-contribution savings plan;
10) Because teachers understand the value of such a plan, they are willing to give up higher wages;
11) A defined-benefit plan encourages a long-term career and stable workforce;
12) Your defined-benefit pension plan provides you with self-sufficiency in retirement; it is associated with far fewer households that experience food privation, shelter adversity and health-care hardship;
13) Your defined-benefit pension plan is less expensive for taxpayers than Social Security – a reason why legislators, et al. had negotiated for Illinois teachers to not pay into Social Security;
14) The Teachers Retirement System of Illinois is the 37th largest in the U.S. with 406,855 members (TRS, 2017);
15) The average investment returns for TRS: 8.8% (for 1986-2016) (TRS, 2016) and 7.54% (for 1996-2016) (TRS, 2017);
16) Your defined-benefit pension plan has an economic impact of over $4 billion on Illinois; the effect on Gross Domestic Product is $2.38 billion; jobs that are created: 30,448 (TRS, 2013);
17) Defined-benefit pension plans contribute over $100 billion to annual local, state, and federal revenue in the U.S. and provide capital to financial markets (NIRS, 2011).

Sources: the National Institute on Retirement Security (NIRS), Center for Retirement Research at Boston College, National Conference on Public Employee Retirement Systems, Center on Budget and Policy Priorities, and the Teachers' Retirement System of Illinois (TRS)