Understanding the Defined Benefit Versus Defined Contribution Choice

56 Pages Posted: 13 Jul 2005

See all articles by Tongxuan Yang

Tongxuan Yang

University of Pennsylvania - Insurance & Risk Management Department

Date Written: 2005

Abstract

Defined benefit (DB) plans and defined contribution (DC) plans are the two main types of retirement pensions sponsored by US employers. This paper explores the choices made by employees in a non-profit firm when offered the option of switching from a DB to a DC plan. Overall, half of the employees switched into the DC plan and half stayed with the DB. We find that both demographic and economic factors affected an employee's plan switch decisions. We also find that the default option - by making no active election an employee remained in the old DB plan - had an important impact on some employees' retirement savings. Surprisingly, half of the employees under age of 40 who could potentially benefit more from the DC plan defaulted to the DB plan, and the DB defaulters were more similar to the DC switchers than DB choosers.

According to the employer's calculation, altogether the defaulted employees with positive opportunity costs have forgone $7M, or 37 percent of their annual salary. Among those who switched to the DC plan, the contribution rates were affected by the DC plan match formula, the employee's age, salary, and other saving. Given the actual behavior of those who switched, there was virtually no change in employer pension expenses after the switch.

Suggested Citation

Yang, Tongxuan, Understanding the Defined Benefit Versus Defined Contribution Choice (2005). Pension Research Council WP2005-4. Available at SSRN: https://ssrn.com/abstract=755064 or http://dx.doi.org/10.2139/ssrn.755064

Tongxuan Yang (Contact Author)

University of Pennsylvania - Insurance & Risk Management Department ( email )

The Wharton School
Philadelphia, PA 19104-6365
United States

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