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
19 Pages Posted: 19 Mar 2019
Date Written: February 7, 2019
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.
Keywords: 401(k) plans, Annuities, Defined benefit plans, Defined contribution plans, Employment-based benefits, Investment performance, Pension plan coverage, Pension plan participation, Retirement income adequacy, Automatic enrollment
JEL Classification: D31, D91, G11, G12, G23, J16, J26, J33
Suggested Citation: Suggested Citation