WASHINGTON — The debate over which is better — defined benefit or defined contribution plans — produced little agreement and lots of heat during a March 12 round table hosted by Pensions & Investments at the National Press Club in Washington.
The DC proponents — Ed Ferrigno, vice president of Washington affairs for the Profit Sharing/401(k) Council of America, Chicago, and Daniel Clifton, executive director of the American Shareholders Association, Washington — insisted the shift was ultimately propelled by employer and employee preference. The two also maintained that DC plans ultimately best serve the interests of plan participants.
But the DB advocates — Damon Silvers, associate general counsel, AFL-CIO, Washington, and Keith Brainard, research director for the National Association of State Retirement Administrators, Georgetown, Texas — attributed the movement toward DC to corporate penny-pinching, a shift that they said would cause workers serious harm.
The one thing that all of the panelists seemed to agree on was that the defined contribution system should be tweaked to include some of the better characteristics of DB plans to ensure DC plans are able to meet retirement needs.
“There are some unique advantages to defined benefit plans that it would be nice to see come into defined contribution plans,” said Kurt Winkelmann, managing director of global investment strategies for Goldman Sachs Investment Management, New York.
“How do we get the kind of professionalism in portfolio construction (for DC plans) that historically we have had through defined benefit plans, how do we get the benefits of scale economies that again we have historically had in defined benefit plans, how do we get the access to skill-based strategies that historically again we have had in defined benefit plans, and, finally, how do we get our hands around some of the risk sharing that has again historically happened in defined benefit plans,” Mr. Winkelmann asked.
He and Roderick G. Crane, the Denver-based director of institutional client services at TIAA-CREF — the panel’s other two members — appeared to take the middle ground in the debate.
Still, that one area of agreement among the panelists prompted Mr. Silvers to say: “That raises the question of why is it that we are moving wholesale … from a system that does all the things we want to do to a system that does none of them?”
Mr. Silvers and Mr. Brainard made clear they believe that DC plans are woefully inferior to the DB plans they are replacing on the nation’s retirement landscape.
Mr. Silvers said the median account balance in a DC plan for workers in their mid-50s is about $60,000 — enough to ensure that a retiree “would be eating dog food” and have sufficient money to otherwise stay afloat only if his or her “life expectancy is measured in months and not in years.”
“The proliferation of defined contribution plans as the primary retirement benefit in this country has diminished the nation’s retirement security,” added Mr. Brainard.
But Mr. Ferrigno said median account data can be extremely misleading because the DC system is adding 4 million new participants every year. In addition, Mr. Ferrigno said defined contribution plans had only been around as a significant program for 15 years or so, limiting the time for contributions.
Mr. Ferrigno also said data generated by the mutual fund industry’s Investment Company Institute and the Employee Benefit Research Institute, both in Washington, indicated a DC plan participant in his or her 60s who has been in a plan for at least six years had $181,000 in his or her account.
With 30 to 35 years of contributions, a DC plan retiree will be fine, Mr. Ferrigno said. “If you do that (contribute for 30 to 35 years), every single indication is that you are going to be at least as good off as, on average, the U.S. worker is in the DB plan,” Mr. Ferrigno said.
According to Mr. Ferrigno, the shift to defined contribution plans from defined benefit has been fueled largely by the preferences of employers and employees alike.
The American Shareholders Association’s Mr. Clifton identified the key motivators of the shift to DC as employee demands to control their own retirement accounts and desires to be able to change jobs without sacrificing retirement benefits.
“What we are seeing is the defined contribution system is evolving as the preferred system,” said Mr. Ferrigno. “It is preferred by employees and preferred by employers.”
But Mr. Silvers said the real reason for the shift was that DC plans are far cheaper for employers than DB plans. The cost to an employer for a typical DC plan is less than 3% of payroll, while a DB plan costs 9% of payroll, he said.
“You can’t do a DB plan without spending real money and you can do a DC plan without spending real money,” Mr. Silvers said. “That is what this is all about in the private sector.”
He said DB plans are better for employees because they yield higher investment returns on lower plan administrative fees. In addition, he said DB plans protect employees from investment- and age-related risks in ways that DC plans cannot.
“What we are actually doing is turning the crank, is tightening the screw on working people,” Mr. Silvers said.
But even so, Mr. Silvers appeared to agree that it would be all but impossible to slam the brakes on the corporate shift to DC plans — a switch he said was ultimately irresponsible.
“The reality is that in a world where everybody else is being irresponsible, it is very hard to be responsible and particularly be responsible and rational,” said Mr. Silvers. “That’s the real dilemma we face today.”
Focus on improvement
With the shift to DC appearing to be a practical reality, the retirement industry should focus on improving DC plans, according to panelists.
“DC plans have a lot of warts,” said TIAA-CREF’s Mr. Crane. “But we are moving in the right direction. Let’s not condemn DC plans if they are the only vehicle that an employee has. Let’s make that vehicle better.”
“What the DC system is doing now is looking at what attributes there are in the DB system that can be carried over,” added Mr. Ferrigno.
At least according to the panelists, one key DC improvement would be to reduce the fees that mutual funds charge DC plan clients. Mr. Ferrigno said the fees ranged from 1% of assets for larger company plans up to 2.5% of assets for smaller plans.
Mr. Clifton said the average fees for DC plans are 70 basis points, but added that his group is working to get that down to 20 to 30 basis points.
Mr. Silvers said that employer indifference to fees — and sometimes employer collusion with the DC plan’s money managers — could lead to higher fees than warranted.
“I think, frankly, that indifference is the biggest problem and also the other problem of course is simply bargaining leverage,” Mr. Silvers said. “You have to get to pretty large size plan to have meaningful leverage in these discussions with the mutual fund industry.”
Panelists agreed DC plan participants need to contribute more money to their DC accounts — although Mr. Ferrigno said employees on average contribute 6% to 7% of wages currently, while the average employer kicks in another 3%.
Mr. Crane said the preferred deferral rate should be 10% to 12% of wages, while Mr. Brainard said that improved longevity and heath-care costs suggested the figure should be 15%.
In addition, several panelists said it would be better for employees in DC plans to have their accounts in lifecycle funds or similar funds where employees are not making the actual investment decisions.
“It is an undisputed fact that most people would rather have a professional manage their retirement assets than do it themselves,” Mr. Brainard said.
It would also be in the best interests of DC plan participants to ensure that “there is some form of mandatory annuitization going on here to make sure the longevity issues are taken care of,” Mr. Crane said.