A new study finds that public sector employees with retirement plan choice overwhelmingly choose defined benefit (DB) pension plans over 401(k)-type defined contribution (DC) individual accounts. Among the eight states studied that offer employees such a choice, the DB pension take-up rates in 2015 were 80 percent or higher in six states. Two of the plans studied had pension take-up rates higher than 95 percent, while Florida and Michigan had take-up rates of 76 percent and 75 percent, respectively.
Importantly, the research finds that even when the retirement plan default option favors a DC plan, most employees still select a DB pension plan. For example, in Washington the default retirement plan is a combination DB/DC plan. Employees must affirmatively act to elect to participate in the DB pension plan instead, and they do. The majority of newly-hired employees – six out of every ten new hires – actively choose a pension plan.
These findings are contained in a new study, Decisions, Decisions: An Update on Retirement Plan Choices for Public Employees and Employers, available here. The research is co-authored by Jennifer Brown, manager of research for the National Institute on Retirement Security (NIRS) and Matt Larrabee, principal and consulting actuary with Milliman.
“When employees have a choice, pensions continue to win in a landslide,” says report co-author Jennifer Brown. “These findings indicate that public employees highly value their pension benefits, which is consistent with NIRS’ polling that finds Americans strongly support pensions for providing economic security in retirement. Notably, our polling also indicates that public employees strongly agree that all Americans should have a pension.”
“Our findings also suggest that the public sector is unlikely to mimic the trend away from pensions as seen in the private sector for two reasons. First, there is strong employee support for pensions. Second, DB pensions remain the most cost-effective way for public employers to provide a modest and secure retirement benefit for employees who typically earn less than comparable private sector employees,” Brown explained.
The research also indicates that employees directing their own investments typically tend to earn lower investment returns than that of state pension plans. The investment advantage in public DB pensions can be attributed to three factors: lower expenses, professional asset management and an optimal investment allocation used by the DB plan over decades. DB pension plans also benefit from longevity risk pooling.
Also, the research examines the issue of states eliminating DB pensions and moving new hires into DC accounts in the hopes of lowering costs or addressing funding shortfalls often caused by states skipping their full actuarial contributions. But, the experience of states shows that such a change has the opposite impact with a DB to DC switch increasing retirement costs for employers and taxpayers in the immediate future.
The new research is an update to a 2011 study with similar findings. To conduct the study, NIRS and Milliman requested information directly from the retirement systems that allow new hires to choose between DB, DC, and combination plans. These systems provided statistics on members that have selected each option. The authors also requested other important provisions relating to benefits and contributions. This primary source material provides a valuable insight into what really happens when public employees are allowed to choose between DB and DC.