Defined benefit pensions remain highly economically efficient, or so says the National Institute on Retirement Security.
The institute on Thursday highlighted several key "efficiencies of DB pensions" that enable them to deliver the same retirement income at what it said was half the cost of a typical DC individual account.
According to its study, "Still a Better Bang for the Buck: An Update on the Economic Efficiencies of Defined Benefit Pensions," DB plans continue to be 48 percent cheaper than DC plans — 29 percent cheaper than an "ideal" DC plan — and provide better benefits.
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There are three structural advantages that account for this: longevity risk pooling; portfolios that are well diversified over the long term and that use a longer time horizon than individual accounts in a DC plan; and the combination of low fees with professional management.
And while DC plans allow participants to manage their own accounts, the study found that participants are operating at a disadvantage for two reasons. First, they do not contribute enough for their assets to grow into a large enough retirement benefit, and second, they make poor investment decisions.
According to the study, the latter circumstance led one team of researchers to conclude that "the likelihood of investment success increases as the participant's involvement in investment decisions decreases."
Although DC plans are supposed to save money, the authors found that not to be the case unless benefits were reduced.
Even annuitizing benefits from a DC plan resulted in lower benefits "because insurance companies use a more conservative asset allocation and charge much higher fees than a DB pension. Annuities purchased at historical average interest rates only modestly decrease DC benefit costs, while annuities purchased at 2014 rates would increase benefit costs."
Even the use of target-date funds did not help DC plans in the study, since they still allow participants to make costly investment mistakes and "most participants do not use TDFs as intended."
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