Defined benefit plans cost 46% less than defined contribution plans because of better investment performance, lower fees and longevity risk pooling, according to a new study from the National Institute on Retirement Security.
According to the study, written by Beth Almeida and William B. Flick Fornia, a DB plan requires annual contributions equal to 12.5% of an employees salary, while a DC plan would require 22.9% to provide the same level of preretirement income replacement.
The report stated DB plans are 26% cheaper than DC plans because DB plan investments returns are one percentage point greater each year, owing to professional investment oversight and lower fees.
Longevity risk pooling saves another 15% because DB plans use the average life expectancy assumption of 85 years old, while individuals with DC plans need to plan for a life expectancy of 97 years old, since only 10% of the population lives beyond that age. Finally, DC plans cost another 5% because individuals need to lower the risk (and therefore the returns) of their investments as they age.
Ms. Almeida said the report aims at being a myth buster regarding the costs of DB plans. Ms. Almeida and Mr. Fornia, advocates of DB plans, wrote plan sponsors might see DC plans as being a cheaper alternative because they tend to offer a lower level of benefits. It shouldnt be surprising that less generous benefits cost less, Ms. Almeida said in a conference call today.
The report is based on modeling of a hypothetical group of 1,000 female teachers who begin working at age 30, take two years off to have and raise children, and retire at age 62.