Comparing the Value of DB and DC Plans

It is possible to estimate the amounts necessary to make the value of defined benefit (DB) plans equal to income paid by defined contribution (DC) arrangements.

That is the conclusion of a new report, “How Much Would It Take? Achieving Retirement Income Equivalency between Final-Average-Pay Defined Benefit Plan Accruals and Voluntary Enrollment 401(k) Plans in the Private Sector,” released by the Employee Benefit Research Institute (EBRI).

“Plan sponsors, providers and policymakers naturally look for comparisons in the outcomes provided. Unfortunately, the comparisons are frequently limited by a scarcity of comparable data,” says Jack VanDerhei, the author of the report and EBRI’s research director.

Before an objective comparison can be made between a DB plan and a DC plan, says VanDerhei, several challenges need to be overcome including:

  • The structural differences between DB and DC plans and how they function;
  • Variations in the job tenure of employees; and
  • Factors that can affect each plan differently, such as investment market returns and annuity purchase prices.

To address these issues, EBRI used proprietary modeling techniques, the full results of which are detailed in the report. In short, EBRI found that calculating a DB plan equivalent to income generated by a DC plan is actually possible, within certain parameters.

In examining median accrual rates, the EBRI modeling found that a DB pension plan would need to range between 1% and 3% of final compensation per year of participation to equal income generated by a DC plan. The modeling also shows that these accrual rates would decrease if investment returns decrease and annuity prices increase.

The full report is published in the December issue of EBRI Notes, which can be found on the institute’s website.