Defined contribution pension plans are sweeping the world. They are mandated in Chile and Australia. They are booming in the United States and Switzerland. Some predict they will surge in the United Kingdom as a result of forthcoming legislation affecting defined benefit plans. A number of countries in Latin America are in the process of following Chile's model, and some in Eastern Europe are studying it.
Not so fast. Is this really the best way to provide retirement income for employees? Defined contribution plans have much to recommend, but in most places they are booming not because the employee benefits marketplace has determined they are the best way to meet the needs for retirement income, but largely because of government favoritism.
The favoritism, in most cases, seems to have arisen either for fiscal or ideological reasons. This alone should give pause to all involved with insuring sufficient pensions.
In the United States, the growth of defined contribution plans largely sprang from legislative burdens imposed on defined benefit plans when the Republican ideology of individual responsibility coincided with the Democratic effort to raise government revenue. In that environment, defined benefit plans had few allies when the full-funding limits and the maximum pensionable salary were slashed as a way to cut "tax expenditures" on pension plans.
These burdens hit companies just as they needed to cut costs to become more competitive in the global economy. So defined benefit plans were replaced or supplemented by defined contribution plans where, at least in 401(k) plans, the employees bear much of the cost.
In Australia, defined contribution plans, called "capital accumulation" plans, were mandated for all employers by the government when the growth of defined benefit plan coverage halted after the government began to tax pension contributions and investment earnings. Ideology played a role, too, as the Labor government liked the idea the assets would be in the names of the employees, not employers.
In Switzerland, the change has been driven in part by new vesting and portability rights for employees and a new allowance to withdraw assets for home purchase, all of which made defined benefit plans too expensive and cumbersome for plan sponsors.
In the United Kingdom, proposed regulations likely will push it more to defined contribution plans also.
Many countries realize they have aging populations and need to provide a mechanism for providing income for people too old to work. But too few, including the United States, have examined which method of providing that old-age income support is the most efficient: which best balances the retired workers' needs and the continued economic health of the country; which system provides adequate retirement income with the least economic distortion.
Is it an unfunded, pay-as-you-go system, such as the U.S. Social Security System? Is it a funded defined benefit system? Is it a defined contribution system? Should it be voluntary or mandatory? Should there be tax incentives?
These questions should be answered before any government shifts its weight behind one kind of plan or another. The U.S. government, especially, should take care not to kill its well-developed, highly funded defined benefit plans through overregulation before being sure that defined contribution plans are better for the employees and the country in the long run.