A rapidly growing public policy concern facing the United States is whether future generations of retired Americans, particularly those in the Baby Boomer and Gen X cohorts, will have adequate retirement incomes. There have been several policy studies in recent years that suggest that the decreasing relevance of defined benefit (DB) plans relative to defined contribution plans (such as 401(k)s) since the 1980s will have a negative impact on the percentage of future retirees who will achieve a specified level of retirement income adequacy.
This Issue Brief provides a direct comparison of the likely benefits under specific types of defined contribution (DC) and DB retirement plans. The DC plans modeled in this analysis represent voluntary enrollment (VE) 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.
The results presented in this Issue Brief show that if historical rates of return are assumed as well as annuity purchase prices reflecting average bond rates over the last 27 years, the median pairwise comparisons result in a strong outcome advantage for VE 401(k) plans over both the stylized, final-average DB plan and the stylized cash balance plan.
When the robustness of these findings are 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 VE 401(k) plans lose their comparative advantage to the stylized, final-average DB plans (at least at the median) for lower-paid employees; however, VE 401(k) plans’ median advantages over the stylized cash balance plans remain in force.
When the simulation results are subjected to both stresses simultaneously, virtually all of the median differences between the VE 401(k) plans and the stylized, final-average DB plan are reversed, regardless of income quartile. However, even in this scenario, based on the median differences, virtually all of the participants will do better in the VE 401(k) plans than the stylized cash balance plan.