Comparing the Value of DB and DC Plans

That is the conclusion of a new report, “How Much Would It Take? Achieving Retirement Income Equivalency between Final-Average-Pay Defined Benefit Plan Accruals and Voluntary Enrollment 401(k) Plans in the Private Sector,” released by the Employee Benefit Research Institute (EBRI).

“Plan sponsors, providers and policymakers naturally look for comparisons in the outcomes provided. Unfortunately, the comparisons are frequently limited by a scarcity of comparable data,” says Jack VanDerhei, the author of the report and EBRI’s research director.

Before an objective comparison can be made between a DB plan and a DC plan, says VanDerhei, several challenges need to be overcome including:

• The structural differences between DB and DC plans and how they function;
• Variations in the job tenure of employees; and
• Factors that can affect each plan differently, such as investment market returns and annuity purchase prices.

To address these issues, EBRI used proprietary modeling techniques, the full results of which are detailed in the report. In short, EBRI found that calculating a DB plan equivalent to income generated by a DC plan is actually possible, within certain parameters. 

In examining median accrual rates, the EBRI modeling found that a DB pension plan would need to range between 1% and 3% of final compensation per year of participation to equal income generated by a DC plan. The modeling also shows that these accrual rates would decrease if investment returns decrease and annuity prices increase.

VanDerhei tells PLANSPONSOR any consulting firm or provider can carry out this comparison for plan sponsors. He advises plan sponsors to ask their consultants or providers about comparing a final-average (DB) plan with various scenarios of a DC 401(k) plan. The parameters of these scenarios may reflect different aims of the plan sponsor, such as recruiting or retaining participants.

He adds that the process does not advocate one type of plan being better than the other. “Plan sponsors will want to look at their specific participant population, so in some cases the results will show that a DB plan will be better for them and in other cases a DC plan will be more appropriate.”

The full report is published in the December issue of EBRI Notes, which can be found on the institute’s website.