Defined Contribution Plans, Defined Benefit Plans, and the Accumulation of Retirement Wealth

51 Pages Posted: 20 Oct 2006 Last revised: 3 Sep 2010

See all articles by James M. Poterba

James M. Poterba

National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Department of Economics

Joshua D. Rauh

Stanford Graduate School of Business; Hoover Institution; National Bureau of Economic Research (NBER)

Steven F. Venti

Dartmouth College - Department of Economics; National Bureau of Economic Research (NBER)

David A. Wise

National Bureau of Economic Research (NBER); Harvard University - Harvard Kennedy School (HKS)

Date Written: October 2006

Abstract

The private pension structure in the United States, once dominated by defined benefit (DB) plans, is currently divided between defined contribution (DC) and DB plans. Wealth accumulation in DC plans depends on the participant's contribution behavior and on financial market returns, while accumulation in DB plans is sensitive to a participant's labor market experience and to plan parameters. This paper simulates the distribution of retirement wealth, as well as the average level of such wealth, under representative DB and DC plans. The analysis considers the role of asset returns, earnings histories, and retirement plan characteristics using data from the Health and Retirement Study (HRS). To simulate wealth in DC plans, individuals are randomly assigned a share of wages that they and their employer contribute to the plan. The analysis considers several possible asset allocation strategies, with asset returns drawn from the historical return distribution. The DB plan simulations draw earnings histories from the HRS, and randomly assign each individual a pension plan drawn from a sample of large private and public defined benefit plans. The simulations yield distributions of both DC and DB wealth at retirement as well as estimates of the certainty-equivalent wealth associated with representative DB and DC pension structures. The results suggest that average retirement wealth accruals under current DC plans exceed average accruals under private sector DB plans, although the heterogeneity in both types of plans implies many deviations from this rule. The comparison of current DC plans with more generous public sector DB plans is less definitive, because public sector DB plans are more generous on average than their private sector counterparts. The ranking of the expected value of retirement wealth accruals, and the certainty equivalent of those accruals, for these two classes of plans is sensitive to assumptions about the asset allocation rules of the DC plan participant.

Suggested Citation

Poterba, James M. and Rauh, Joshua D. and Venti, Steven F. and Wise, David A., Defined Contribution Plans, Defined Benefit Plans, and the Accumulation of Retirement Wealth (October 2006). NBER Working Paper No. w12597. Available at SSRN: https://ssrn.com/abstract=937298

James M. Poterba (Contact Author)

National Bureau of Economic Research (NBER) ( email )

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Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Joshua D. Rauh

Stanford Graduate School of Business ( email )

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Hoover Institution ( email )

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National Bureau of Economic Research (NBER)

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Steven F. Venti

Dartmouth College - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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David A. Wise

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Harvard University - Harvard Kennedy School (HKS)

79 John F. Kennedy Street
Cambridge, MA 02138
United States

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