3Center or American Progress Action Fund | In Deense o Deined-Beneit Pensions
For any given level o reiremen benes, dened-bene plans are less expensive han401(k)-syle dened-conribuion plans. Ta means ha in order or workers o reire wih, or example, 75 percen o heir pre-reiremen income (he level recommended by many reiremen planners), i is cheaper o do so wih a dened-bene pension plan.Te same holds wih any oher level o reiremen income. Ta’s because dened-bene- plans have higher reurns, more balanced porolios, and greaer abiliy o pool risk. All old, dened-bene plans cos abou hal as much as dened-conribuion planso provide he same level o bene due o hese eecs, according o research by heNaional Insiue on Reiremen Securiy .
Dened-bene plans achieve hese cossavings because o he way hey are srucured as a large, diversied, proessionally man-aged invesmen und, wih he abiliy o maximize reurns over a long ime horizon.In conras, dened-conribuion plans are small, worker-man-aged invesmen unds wih a ime horizon ha varies dramai-cally based on he worker’s age. Te sudy nds ha providing workers wih a secure level o reiremen income would cos 12.5percen o payroll wih a dened-bene plan bu 22.9 percen o payroll wih a dened-conribuion plan. Wha’s more, he sudy breaks down he dened-bene plan savings o nd ha hey deliver superior invesmen reurns savings o 26 percen (due oproessional managemen), longeviy risk pooling savings o 15percen (due o he abiliy o plan or average lie expecancy),and porolio balancing savings o 5 percen (due o he more balanced porolios o managed unds)—or a combined savingso 46 percen. (see Figure 1)Dened-bene plans average higher invesmen reurns in par because invesmen decisions made by proessional invesors aremore likely o be wiser invesmens han hose made by ordinary workers. Individuals have o become more conservaive wheninvesing as hey age because hey have less ime o recover any possible losses (resuling in lower reurns) bu individuals ofendo jus he opposie (depleing heir savings). Tese pensionplans also have he abiliy o pool invesmen risks over a longer ime period and agreaer number o people compared o a dened-conribuion plan. When accouns o boh older and younger workers are pooled ogeher, he und manager can shoo or ahigher reurn as he plan has a much longer invesmen ime horizon.One sudy o he dierence in reurns by he global benchmarking rm CEMBenchmarking Inc. nds ha beween 1998 and 2005 dened-bene plans hadannual reurns 1.8 percenage poins higher han dened-conribuion plans.
Overime his seemingly small dierence can be signican due o compounding growh.
Why Traditional Pensions Cost Less
The cost of a defined-benefit pension plan and adefined-contribution pension plan as a percent of payroll
Deﬁned-contribution planDeﬁned-beneﬁt planDeﬁned-beneﬁt costLower investment returnsLess balanced portfolioNo longevity risk pooling
Source: Beth Almeida and William B. Fornia, “A BetterBang or the Buck: The Economic Eciencies o DefnedBeneft Pension Plans,” (Washington, DC: NationalInstitute or Retirement Security, 2008.