Case Study: A Better Bang For The Buck

This file was not written exclusively by me. It was written by the California Retired County Employees Association, Retirement Security Committee for edit and approval of the Executive Board. I was a member of the Executive Board (Secretary) in which I contributed to and have their permission to use.

TRANSITION TO 401(k) PLANS
A TRAIN WRECK IN THE MAKING

PART II IMPACTS ON THE ECONOMY The Damaging Effects of Taking Defined Benefit Funds Out of Play California Retired County Employees Association Retirement Security Committee September 2012

CRCEA - P.O. Box 706, Merced CA 95341-0706 www.crcearesearch.com

EXECUTIVE SUMMARY

Private sector employers have, for the most part, terminated
The NIRS study, which has been supported in multiple works throughout the nation, finds that the current defined benefit plan system can produce the same benefit at 46% or almost half the cost of 401(k) type plans due to three structurally inherent components not part of 401(k) type plans. These are: 1. Maintenance of a balanced portfolio diversification in a defined benefit plan saves 5%; 2. A defined benefit plan’s superior investment returns save 26%; and 3. Longevity risk pooling in a defined benefit plan saves 15%.

On this last point, it is worth noting that longevity risk pooling provides a major advantage to employers and taxpayers that is virtually ignored in the current pension reform debate. Essentially, pension plan participants agree to forfeit and donate back to the retirement pool the vast majority of their pension assets should they die prematurely - even one day prior to retirement. This allows provision of greater benefits at lower overall costs than is possible with 401(k)
With seriously lower cost per dollar of benefit provided, why is continued primary use of the defined benefit plan based system often rejected out of hand in the current debate in favor of transitioning to the more expensive 401(k) product? Would it not make more sense to switch the focus to the real long term economic impacts each of the plan types provides, and implement corrections to potential abuse issues that have come to light?

A popular argument in the press and by proposers of either of the above two scenarios is that transitioning to 401(k)s would reduce or eliminate the employer’s defined benefit plan unfunded liability sometime in the future. Assuming the conversion applies to new hires, this “benefit” may not be fully realized for a lifetime. Unfortunately, what may be realized much sooner are significant and very harmful impacts, not the least of which is the upward pressure on salaries due to demands typically spawned by the reduced value of 401(k)s to the individual employee's retirement security. Increased salaries are paid dollar for dollar, as opposed to DB plan increases that vary but are always a far lesser share, 27% being the national average of a pension dollar