Do Employees End Up With More Retirement Income Under Automatic Enrollment 401(k) Plans Than Final-Average Defined Benefit Plans?

In many cases… yes, according to a new study

Washington, D.C. – February 26, 2019 — The Employee Benefit Research Institute (EBRI), a private, nonpartisan, nonprofit research group, has released a new study examining the level of benefits that 401(k) plans with automatic enrollment provide compared to final-average defined benefit (DB) plans — with some potentially surprising results.

The Issue Brief is “How Much Would It Take? Achieving Retirement Income Equivalency Between Final-Average-Pay Defined Benefit Plan Accruals and Automatic Enrollment 401(k) Plans in the Private Sector.” In it, EBRI’s Retirement Security Projection Model® is used to compare simulated retirement benefits available under 401(k) plans with automatic enrollment relative to benefits available from a counterfactual simulation of a high-three-year, final-average pay defined benefit plan.

DB Plans Must Work Harder

All things equal, it shows that DB plans would typically have to accrue at more-generous rates to “break even” with auto-enrollment 401(k) plans. For example:

  •  In its baseline case, EBRI found that the defined benefit “break-even” rate — or the percentage accrual rate that would be required in order for a final-average DB plan to generate the same retirement income that is projected to come from 401(k) plan eligibility under automatic enrollment for a given worker cohort — are rarely less than 1.5 percent of final pay.
  • In only 2 of the 16 combinations of wage quartiles and years of plan eligibility for males are defined benefit “break-even” rates less than 1.5 percent of final pay per years of service.
  • For women, only 5 of the 16 combinations have “break-even” rates under 1.5 percent.

“EBRI’s modeling results show a strong advantage for automatic enrollment 401(k) plans over final-average defined benefit plans under this scenario,” said Jack VanDerhei, EBRI research director and author of the study. “However, when subjected to various ‘stress tests’ this can change.” VanDerhei notes that, for example, by reducing the rate of return assumptions by 200 basis points and increasing the annuity purchase price to reflect recent bond rates, results show
that in many cases the automatic enrollment 401(k) plans lose their comparative advantage to the final-average defined benefit plans.

Excerpts from the Issue Brief: How Much Would It Take?

Achieving Retirement Income Equivalency Between Final-Average-Pay Defined Benefit Plan Accruals and Automatic Enrollment 401(k) Plans in the Private Sector

results show a strong advantage for automatic enrollment 401(k) plans over final-average defined benefit plans...

  • 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) plans) since the 1980s will have a negative impact on the percentage of future retirees who will achieve a specified level of retirement income adequacy.
  • Previous EBRI research reported on a comparative analysis of future benefits from private-sector, voluntary enrollment (VE) 401(k) plans and stylized, final-average-pay defined benefit plans.
  • The current research expands the previous research by computing the actual final-average DB accrual that would be required to provide an equal amount of retirement income at age 65 as would be produced by the annuitized value of the projected sum of the 401(k) and IRA rollover balances under automatic enrollment (AE) 401(k) plans.
    Assuming historical rates of return as well as annuity purchase prices reflecting average bond rates over the period from 1986 to 2013, the analysis shows that:
  • For males, defined benefit “break-even” rates — or the percentage accrual rate that would be required in order for a DB plan to generate the same retirement income that is projected to come from 401(k) plan participation for a given worker cohort — are rarely less than 1.5 percent of final pay: in only 2 of the 16 combinations of wage quartiles and years of plan eligibility for males are defined benefit “break-even” rates less than 1.5 percent of final pay per years of service.
    In the case of females, only 5 of the 16 combinations have “break-even” rates under 1.5 percent.
  • When these findings are subjected to the scrutiny of various “stress tests” both by reducing the rate of return assumptions by 200 basis points as well as utilizing current annuity purchase prices, results show that in many cases the AE 401(k) plans lose their comparative advantage to the stylized, final-average DB plans, especially for lower-paid employees as demonstrated by the lower “break-even” accrual rates.

VanDerhei points out that this research is important because “in considering shifts in plan availability and design, plan sponsors, providers, and policy makers naturally look for comparisons in the outcomes provided. Unfortunately, the comparisons are frequently limited by a paucity of real-world data.”

Copies of the report summary are available at ebri.org.

 

 

About EBRI:
The Employee Benefit Research Institute is a private, nonpartisan, nonprofit research institute based in Washington, DC, that focuses on health, savings, retirement, and financial security issues. EBRI does not lobby and does not take policy positions. The work of EBRI is made possible by funding from its members and sponsors, who include a broad range of public, private, for-profit, and nonprofit organizations. For more information go to www.ebri.org