Switch From DB to DC Lowered Retiree Replacement Income

New research from the Center for Retirement Research at Boston College (CRR) suggests the change in the retirement landscape from predominately defined benefit plans to mostly defined contribution plan coverage has decreased both household pension wealth and retiree income replacement rates.

According to the CRR Issue Brief, during the period 1992 – 2004, the increase in DC plan participation and plan balances as DB plan coverage declined, was not enough to maintain average household benefits and income replace­ment rates. The typical household with a head who was 51-56 years old had about $114,000 in pension wealth in 2004, about 11% less than in 1992, the report said.

In addition, the CRR researchers found that between 1992 and 2004, the ratio of expected benefits to total current earnings of households (income replacement rate) declined from 32% to 26%.

The researchers pointed out there will be a continuing dependence on employer-sponsored retirement plans as the role of Social Security lessens. According to the report, Social Security currently replaces around 40% of pre-retire­ment income for the average household, however, three factors will lead to a reduction of benefits relative to pre-retirement earnings:

  • The increase in full retirement age from 65 to 67,
  • Medicare premiums, which are deducted from Social Security are slated to rise dramatically, and
  • A greater share of benefits will be taxable under the personal income tax because the threshold levels above which benefits become tax­able are not indexed for inflation or wage growth.

The CRR used data from the Health and Retirement Study (HRS) for its comparison of employer-sponsored pension wealth across households with heads age 51-56 in 1992, 1998, and 2004.

HRS data indicated that in 1992, 62% of households were covered by an employer-sponsored plan, compared to 66% in 2004. However, while overall plan coverage remained stable, the proportion of older households with pensions relying solely on a defined benefit plan declined from 36% in 1992 to 19% in 2004.

At the same time, the number of households depending only on defined contribution plans for retirement income increased from 27% in 1992 to 44% in 2004. The number of households with both DC and DB coverage remained relatively stable (37% in 1992 v. 38% in 2004).

The CRR Issue Brief can be found here.