SURVEY SAYS: Can a DC Plan Provide as Adequate Retirement Income as a DB?

Last week I asked NewsDash readers: Do you think defined contribution plans can provide retirement income as adequately as defined benefit plans?
By PS

The majority (52.2%) said no. Nearly 19% said yes they could, and 29% said DC plans can provide retirement income as adequately as DBs, but only if some changes are made. 

 

“Other” responses included:  

  • Only if participants are adequately educated about how much they need to invest and how to invest appropriately to their situation. 
  • It depends on too many variables and, therefore, the result is uncertain. Market volatility, whether you retire after a bull market or a bear market, how you save, how long you save, how you invest, the employer contribution/support to mention only a few. 
  • Employees must participate — that is, “save.” Employees must learn basic principles of financial management (aka budgeting) and they must learn to control spending. Loans from 401k’s should be forbidden. We must re-learn basic self control when it comes to spending — something our ancestors who lives through the 1930’s and war years clearly understood. Individual responsibility is an absolute. Someone else’s retirement is NOT my responsibility. 
  • The amount of contribution made to the plan will have the most impact on the final balance. If participants save at the appropriate level, they will have enough to retire. 
  • Keep in mind that even a defined benefit plan does not provide for a secure retirement, individuals have to save in other retirement products such as IRA’s and 401(k)’s and also invest in non retirement accounts as well. 
  • “woefully inadequate” is an understatement 
  • Only because they have to. Companies simply can’t afford to pay employees enough to maintain a modern American standard of living AND fund a DB plan that can provide for a workforce that is living so much longer AND provide medical benefits that are of any use. 
  • To my understanding they were not meant to replace DBP, they were supposed to be a separate “savings” vehicle. The third leg of the stool, pension and social security benefits being the other two legs. 
  • Absolutely not!! 
  • Dc plans were meant to augment traditional pension plans, by providing a tax effective means by which to save, they were not intended to take over for them. 
your question presumes that defined benefit plans provide retirement income adequately – they do so only if they are funded sufficiently (and appropriately), and only if/when certain age/service requirements are met. Since the median job tenure in the private sector has only been 4 years as long as the goverment has tracked it (1952), it’s questionable just how “adequately” they have provided retirement income for most workers. When you notice that the median annual pension benefit in the private sector is something on the order of $10,000 – well, you can draw your own conclusions.

I also asked readers what it would take for a DC plan to provide retirement income as adequately as a DB. More than one answer could be chosen. 

 

A large majority (69%) said employee deferrals would have to be mandatory.  This was followed by nearly 59% who said the DC plan would have to use automatic enrollment and automatic deferral escalation. 

 

Thirty-one percent chose retirement income products in the DC plan, and 29% chose increased participant advice. Twelve percent said the plan would have to use managed accounts only and five percent said the plan would have to use target-date funds only. 

 

Many of the “other” responses pointed out that I regrettably omitted mandatory, or higher, employer contributions from my list.  

 

“Other” responses included: 

  • You're completely missing the boat here!! The only way DC can truly take the place of the DBs is by mandating a certain level of employER contributions!! It's not investment advice, target date funds, or auto enrollment...the employer has to live up to THEIR part of the puzzle otherwise NO employees without a DB will ever be able to retire. 'Nuff said. 
  • Significant employer contributions No loan capability No hardship withdrawals An insurance protion in the event of disability, illness, etc. Possibly pooled investments to avoid individual risk, lower costs, and provide a greater time horizen 
  • Include a defined benefit option among the 401k choices 
  • Roughly 23% of pay contributed annually, with extremely limited ability to take a distribution prior to age 60. Distribution should be in the form of a low-fee annuity for life based on a percentage of the account balance, with a fixed percentage of the account balance available for lump sum withdrawal. 
  • Bigger contribution commitment from employer (25 -50 cent on the dollar match won't help much). If an individual needs to save roughly 18% a year, that's tough to do via a 401(k) alone, without more helpf from the employer. 
  • I think the biggest hurdle is the safe harbor system for employer matching. While I'm a little fuzzy on the details, I think only 6% of pay can be a safe harbor percentage for employers. This limitation was set when many employers had both DB and DC plans. As employers close and freeze DB plans, this safe harbor amount must rise. I see no reason why it could not be 10% or more, particularly if there is no DB plan. Whether employers adopt a higher match is up for debate, but the option should be there. Retirement income products are also necessary, but there must be a way to avoid the ridiculous fees that insurers charge. No one wants to take a 5% or larger haircut on their assets because of a sales commission. Annuities would be great if the costs could get more aligned with something like an indexed ETF or mutual fund. Groupon should enter the annuity market... once a critical mass is hit (say 10,000), the "fair fee" annuity is purchased for everyone. 
  • Greater employer contributions 
  • A conversion to a DB plan.. 
  • Requires higher contribution costs than DB. 
  • I don't see mandatory employer contributions on your list, which I believe is essential to even coming close to being as adequate as a DB plan. It's going to take more than what you have listed - though some on your list would not have any impact at all. 
  • Retirement income products might help, but to me the underlying problem is the lack of financial literacy and expertise necessary to successfully plan a retirement that might have to last for 30 years or more. Too much responsibility has been pushed onto the employee, who in most cases, is ill equipped to handle them properly. 
  • Get rid of all compliance testing; perhaps increased incentives for high matching contributions. 
  • lower fees 
  • Mandatory company contributions, if an employer is used to making sizable DB contributions a 50% match on the first 6% of deferrals would be "inexpensive" to them. 
  • Also, higher employer contributions 
  • There would need to be some kind of contribution by the employer to reach the amount necessary to allow for retirement. 
  • DC plans should not allow the participant to take a loan or a hardship withdrawal. DB plans do not allow this. Also, due to the fact that employees do not stay at one job their entire career any more and make multiple changes, DC plans should automatically be transferred to the new company. 
  • The availability of 401(k) loans and hardship withdrawals as well as the ability to cash out one's account after termination may help participants in the short-term, but these are severely detrimental to achieving the long-term goal and purpose of retirement plans. All of the things that employers can do to encourage participation such as auto enrollment or a company match as well as offering target-date funds or qualified default investments are all for naught when too many participants cash out their accounts after termination which destroys their ability to accumulate any money to provide income for their retirement. 
  • Required employer contributions for all employees 
  • Mandatory ER contributions Protected funds that employees cannot touch by loan or early withdrawal 
  • If you have the same balance, you can get the same income from a DB or a DC plan. 
  • Larger employer contributions, very limited withdrawal and loan options. 
  • Matching Contributions 
  • eliminate loans & pre-retirement withdrawals 
  • Mandatory company match 
  • Even if all of the above were implemented, the very nature of the employee assuming the risk, and the timing of the need for the funds coinciding perfectly with the highest value to support that need in every situation is an unlikely assumption to be met. 
  • Can't do it. If you want to provide lifetime income in the most effective manner, nothing works as well as a DB plan. 
  • Someone needs to teach sponsors how DC plan fees "work" and by work I mean work to earn providers enormous revenue sharing based pay days. 
  • Don't allow loans or hardship withdrawals. Even with that and the items above, I still think they're not an adequate replacement. 
  • The only way to provide an adequate benefit if only DC plan is offered is if the DC plan included mandatory contributions (employee and employer), investments handled solely by a professional selected by the employer, and benefits are paid as guaranteed lifetime income - in other words, a DB plan 
  • Higher levels of employer contributions (either matching and/or profit sharing) 
  • If you run - and fund - a DC plan like a DB plan, it will provide the same result. That means defining the benefit, and then putting enough aside to fund that benefit. You can do some/all of the things above as ways to get there - but what it gets down to is focusing on how much benefit you want/need, rather than how much money you (think you) can afford to set aside now. 
  • Not a realistic goal for most. 

As for the verbatims… well, readers had much to say! 

 

  • Employers are not likely to be willing to go back to the unpredictable costs of a DB, even though they are a more efficient way to invest for retirement due to pooling of mortality risks. 
  • All the literature appears to indicate that DC plans are not providing sufficient retirement income, employees don't know enough to properly invest and tolerate risk and volitility, and that there is a brewing problem. DC plans need a serious overhaul if they are ever to provide a proper retirement income for the mainstream of employees. 
  • For disciplined savers, I believe a DC plan can adequately replace a DB plan; however, the majority of participants are not disciplined savers. 
  • Pretty much a disaster. But this is what corporate America wants, so this is what we have. 
  • It’s not hard to see why many employers have jumped at the chance to replace workers on DB pensions with new workers not having DBs. It’s a way to increase profits by cutting compensation costs. But why would workers throughout the private sector willingly agree to such a cuts in overall compensation? One reason that most didn’t object is that they probably didn’t know or didn’t grasp what was happening. This is partly because they were not provided with sufficient information. Also, economists and psychologists have established that even when people are provided this information, the vast majority of them are surprisingly poor at evaluating the implications. For most people, distant benefits like pensions are abstractions to which they pay little attention. Until they get close to retirement, of course. In the public sector, DB pensions are often viewed as an excessively “expensive” component of compensation. But the simple fact is that retirement is expensive. Instead of coming to terms with this fact, Americans are cycling through various alternatives in the hopes that one of them will somehow render retirement cheap. One of the "solutions" is to rely entirely upon 401(k)-style accounts, since they are a much cheaper way to save for retirement. But a closer look reveals that these accounts are not cheaper and have left millions of Americans with drastically underfunded retirement accounts. At the end of the day, saving for retirement is both necessary and expensive. This will be true regardless of the approach. A reasonably structured DB pension remains a highly efficient way to deliver the core of wealth that people need for retirement. One reason that most didn’t object is that they probably didn’t know or didn’t grasp what was happening. This is partly because they were not provided with sufficient information. 
  • Overall bad idea - employers are put on the seat of providing directly or indirectly financial advice to ensure employees to not elect high-risk investment options. Since employees now change jobs much more frequently there is a high probablility, particularly with those under age 35, they will cash out repeatedly in the years they need to be building the base for a secure retirement at age 70. Like it or not, "big-brother" DB plans that do not allow a cash out are the only way to not create a generation of retirees on welfare. 
  • DC plans lack the long term goals of DB plans and are portable which impede long term goals. A partial solution may be regulations that requires a part of the assets to be invested and retained in retirement income products. These products can be chosen by the participant but only available,e.g., after the participant reaches 59 or 60 years old. 
  • DC plans were meant to supplement the income retirees received from Social Security and DB pensions. Longevity risk is aggregated in DB plans in a way that individual DC participants can never do on their own. DC plans as they exist today cannot alleviate the risk of running out of money if one lives longer than expected. 
  • If defined contribution plans are good enough for the private sector, then they should be good enough for the public sector as well. 
  • I think it is better to offer both, with the contributions to DB plans made solely by the company and the contributions to DC plans made solely by the employee. 
  • No surprise given the extreme level of regulations on DB plans. The more rules that get put into place, and the more restrictive those rules get has pushed everything towards a much more transparent framework (DC). 
  • The problem is not with the design of the retirement program, the problem is with the funding. Both DB and DC plan designs CAN provide adequate retirement income to participants, but only if enough money is put into them. The 401k plan design was simply a cost sharing strategy, i.e. shift part of the funding burden to employees. But employers have seized on it as an opportunity to reduce their retirement contributions and everyone is blaming participants for not putting in enough of their own money. The biggest shift in the past 20 years is employers have steadily reduced their contribution level and backed away from their responsibility to help FUND employee retirement benefits. 
  • Just like Social Security, private accounts for retirement savings will always increase the average cost per participant. In a true DB arrangement, the people who die young leave actuarial gains in the system that are used to pay future benefits to people who live a long time. If you take away the actuarial gains and keep the losses (because others are still going to die old) the cost of providing the retirement benefits increases. 2. Employees with individual accounts invest into a headwind and as a result end up buying high and selling low. When the economy booms employees increase their accounts with not only their own contributions, but also employer contributions. When the recession comes and people lose their jobs (and the stock market is low), desperate people are forced to take out money to survive. Even those who are fortunate to stay employed during the recession, oftentimes lose their employer match during the tough times (while the stock market is low). 3. Employees in a DC arrangement tend to pay higher transaction costs than those that can be negotiated by a DB plan with a large pool of assets. 4. Each person in a DC plan has to save enough money to live a very long time, just in case they do. In a DB arrangement, the plan only needs enough money for each participant to live the average life expectancy for the group. Some will die young and others will die old, but on average they will die at the average life expectancy. 4. The benefits of a DB plan are really all about economic efficiencies that come from spreading the risk and having a large enough pool of money to get economies of scale that reduce transaction costs. These efficiencies are realized throughout the full cycle of participation from the first day of contributions to the last day of benefits paid. If the participants are segregated into separate accounts during any phase, the economic efficiencies of that phase are permanently lost. 5. Individuals are usually advised to be a more aggressive investor when they are young and to become more conservative as they grow old. A DB plan does not have to make this shift and can generally maintain level expected investment returns perpetually. I saw a recent study that said it requires 46% more money to provide a specified retirement benefit in a DC arrangement compared to a DB arrangement. This makes sense to me, but I haven't seen any competing studies on this issue. I would be very interested in knowing how the shift is expected to affect our economy. If people are scared of running out of money and trying to save enough money to live past 100, they will stay in the workforce and occupy jobs that might otherwise go to younger workers. If people are scared enough that they cut back on current consumption to save for retirement, there will be lower consumer confidence and spending. Lower consumer spending should result in less corporate expansion. Meanwhile, there will be more investment dollars in these accounts chasing investment opportunities. The idea that employers should shift from a DB plan to a DC plan, because today's workforce tends to job hop more, never made much sense to me. Yes, it is a trend that employers should recognize and incorporate into succession planning. I just don't understand why employers should use their employee benefit arrangements to enable this practice. 
  • The greatest scam ever foisted on the American worker. We will pay dearly. 
  • DC plans should only be considered an individuals extra efforts to save for a more comfortable retirement. DB plans are the base of retirement income to help supplement Social Security. DB plans should be like SS in that it's required to participate. People just aren't disciplined enough to save on their own. 
  • Establishment of additional welfare plans is coming to a state near you. 
  • In the beginning, DC plans were meant as a supplement to the DB plans and social security. It wasn't suppose to supplant it. DC plans, in combination with Social Security and DB plans, are effective means of keeping retirees in the middle class and not falling below the poverty level. 
  • As I recall DC plans started out as "salary reduction plans" that may have been attractive to upper income managers as a way to reduce their taxes, but has since morphed into a way for corporations to reduce their expenses and liability by forcing the employees to shoulder the burden of planning and funding their retirement. 
  • If the huge contributions that go to Public DB plans were made to DC plans, everyone would have adequate retirement funds. BTW, why should public employees enjoy cadillac retirement benefits that are much more generous than the retirement benefits for taxpaying, corporate workers? 
  • The question shouldn't be how to reduce the benefits of DB plans, but how Industry is shirking its responsibilities to its employees with DC plans. 
  • Plans keep adding features to 401(k) plans to make them more like DC plans, e.g. automatic participation, target date investments, investment advice and/or management. Has it ever occurred to anyone that maybe changes should be made in the law that just make it easier to run a DB plan instead of making a DC plan operate as a de facto DB plan, but with the employee taking all the investment risk? 
  • I think that the problem is not DB or DC but the fact that people are living longer (retiring earlier) so more money is needed to cover all retirement expenses. DB plans were all right when people didn't live 20 to 30 years after retiring. 
  • We have all seen private sector companies declare bankruptcy. Workers with 20+ years at the company may see pennies on the dollar -- if anything. Public sector pensions are a luxury -- "guaranteed" by the taxpayer. 
  • When DC plans replaced DB plans, many employers discontinued their committment to their employees future well-being. This created a whole class of employees who, not being financially educated and possibly barely meeting their current financial needs, are unable to understand how to adequately plan for their own futures. 
  • When I entered the workforce in 1981, I had a low salary and but was eligible for the company DB plan. I did not have the option of electing out of the DB plan for more cash compensation like DC plans essentially offer. Thank God. I now have a future benefit at 65 from the DB plan about equal to what I can expect from Social Security. If I had the choice in 1981 to elect cash in lieu of the DB plan, I likely would have taken the money and gone to nicer bars. 
  • This formula is pretty simple. If you save enough over your career, you will have enough to retire. We do not save enough as a society and we therefore face a shortcoming in retirement. 
  • DB plans should not have been replaced by DC plans, employers should have offered DC plan in addition to a DB plan. With that said. I have not worked for any companies that offer DB plans so having a secure retirement is up to me. It is important to educate employees to make better choices. 
  • DB plans often offer unrealistic benefits that can jeopardize a company's financial stability. DC plans, with proper education and affordable funding along with individual savings, can provide an adequate pension. DB plans can not be expected to provide the same benefit they provided in the past when people are retiring at age 55 and living to age 85. 
  • stupid, stupid, and did I already say stupid? 
  • The vast majority of people are more worried about their needs today than preparing for tomorrow. We are a borrowing culture and unless you force people to save for many, they will not have enough. 
  • Let's be truthful...this was never intended, at least not by corporate sponsors. I have worked in this busines for almost 40 years with 5 different companies and have never heard senior management say "What will this change do to our retirement strategy for our employees?" 
  • DB plans have two features that are not being duplicated in DC plans. First, DB plans were generally paid for only by employers. Most DC plans require employee contributions to provide "similar" levels of benefits. Second, DB plans automatically pool longevity risk. Even if annuity products are added to DC plans, that risk is paid for individually, which is far more expensive. In addition, DC plans spent a disproportionate amount of the funding on shorter-service employees who terminate prior to retirement. Retirement plans should spend most of the money on long-term employees, which is what happens in the typical DB plan. 
  • I sometimes get the feeling that people are clinging to the DB concept because it nurtures their longing to believe that "the good old days" are not in fact long gone. 
  • I worked in the DB field for 4 of my 25+ years in the industry and saw plenty of DB plans with very inadequate benefit accruals - yet the masses would keep working to accrue that benefit thinking it would be all they needed plus their SS to survive. Employers can be just as stingy in their benefit accruals as they can be in a match - so what's the difference? At least a 401k allows the participant to make up some difference tax-deferred. 
  • I'm not saying that it should be done, but the only way a DC plan could compete with a DB plan is if participants had minimum contribution amounts similar to employer funded DB plans. Very difficult to imagine. 
  • I think it was a bad idea and many employees are in shock when they realize that they don't/won't have a traditional 'pension" like their parents. 
  • DB plans are great but in today's global economy few employers can afford them and/or accept the enormous volatility . Couple that with ever increasing and onerous regulations and voila most employers move to the DC plan. 
  • This is such a bad idea. Policy makers should be trying to find a way to save DB plans, not replace them. They are a critical part of the three legged stool - Social Security, employer benefits and personal savings (through a DC plan). A mix of DB and DC plans offered by the employer is the best approach for helping workers achieve a secure retirement. 
  • Too much risk has been placed on employees requiring them to be disciplined in participating in DC plans, maximizing the plan's benefits and grounded in sound investment strategies. Achieving widespread conformance with those goals is highly unlikely. Once again, the government has overegulated the pension arena effectively negating the dynamic of a sound retirement delivery system. The demise of DB plans is the result. 
  • the sooner people understand/appreciate the reality of defined benefit structures with how Americans actually work, they will - I think - gain a better appreciation for the opportunities with a defined contribution approach. Sure, we'd all like to have someone else pay the full freight for us to spend 30 years in retirement - but once you wake up from that dream of something that never really fully existed for most, you'll be better able to deal with reality. 
  • Tragic. 
  • People are cheap. Employees need to be made to enroll. For some reason, they think that even 1% of their paychecks would be too much and they can't afford it. They want the money in their paychecks NOW. They are going to be distraught at age 65 when (if?) they get a SSN check that will not allow them to survive, let alone retire. 
  • For savers, it would work. For the majority, they never get around to saving for tomorrow. 
  • This would assume that DB plans actually provide what they promise, rather than being underfunded, moved to the PBGC and changing what was promised to the beneficiaries. 

 

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