Is DB or DC Better for Participants?

The Employee Benefit Research Institute (EBRI) said a multitude of factors affect the ultimate outcome for retirement plan participants such as: interest rates and investment returns; the level and length of participation; an individual’s age, job tenure, and remaining length of time in the work force; and the purchase price of an annuity.

“If historical rates of return are assumed, as well as annuity purchase prices reflecting average bond rates over the last 27 years, and real-life job tenure experience, EBRI’s modeling results show a strong advantage for voluntary-enrollment 401(k) plans over both the final-average defined benefit (DB) plans and cash balance plans,” said Jack VanDerhei, EBRI research director and author of the study.

“However, when subjected to various ‘stress tests’ by reducing the rate of return assumptions by 200 basis points and increasing the annuity purchase price to reflect today’s bond rates, results show that in many cases the voluntary-enrollment 401(k) plans lose their comparative advantage to the final-average DB plans (at least at the median) for lower-paid employees, though voluntary-enrollment 401(k) plans’ median advantages over the stylized cash balance plans remain in force.”

The baseline analysis uses the median level of employer generosity for both final average DB plans and cash balance plans, but when the simulations are re-run with more generous provisions for the DB plans, the relative advantages of the 401(k) plan decrease.

EBRI used its Retirement Security Projection Model to provide a direct comparison of the likely benefits under specific types of defined contribution (DC) 401(k)-type plans and DB retirement plans. The DC plans modeled in the analysis represent voluntary-enrollment 401(k) plans, while the DB plans are represented by two stylized plans: a high-three-year, final-average defined benefit plan and a cash balance plan.

VanDerhei said one additional factor that that should be taken into account when comparing the two different types of plans is that workers often contribute to 401(k) accounts, unlike traditional DB pensions, which in the private sector are typically funded exclusively by the employer. He noted this particular research did not consider the impact of automatic-enrollment 401(k)s.

Full results of the study have been published in the June EBRI Issue Brief under "Reality Checks: A Comparative Analysis of Future Benefits from Private-Sector, Voluntary-Enrolment 401(k) Plans vs. Stylized, Final-Average-Pay Defined Benefit and Cash Balance Plans," available here.