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

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  • James Poterba
  • Joshua Rauh
  • Steven Venti
  • David Wise

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.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12597.

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Date of creation: Oct 2006
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Publication status: published as Poterba, James & Rauh, Joshua & Venti, Steven & Wise, David, 2007. "Defined contribution plans, defined benefit plans, and the accumulation of retirement wealth," Journal of Public Economics, Elsevier, vol. 91(10), pages 2062-2086, November.
Handle: RePEc:nbr:nberwo:12597

Note: AG CF LS PE
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  1. James M. Poterba & Steven F. Venti & David A. Wise, 1999. "Implications of Rising Personal Retirement Saving," NBER Working Papers 6295, National Bureau of Economic Research, Inc.
  2. James Poterba & Joshua Rauh & Steven Venti & David Wise, 2003. "Utility Evaluation of Risk in Retirement Saving Accounts," NBER Working Papers 9892, National Bureau of Economic Research, Inc.
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  4. James M. Poterba & Steven F. Venti, 1998. "3. Lump-Sum Distributions from Retirement Saving Plans: Receipt and Utilization," NBER Chapters, in: Inquiries in the Economics of Aging, pages 85-108 National Bureau of Economic Research, Inc.
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  6. Poterba, James & Rauh, Joshua & Venti, Steven & Wise, David, 2007. "Defined contribution plans, defined benefit plans, and the accumulation of retirement wealth," Journal of Public Economics, Elsevier, vol. 91(10), pages 2062-2086, November.
  7. James M. Poterba, 2003. "Employer Stock and 401(k) Plans," American Economic Review, American Economic Association, vol. 93(2), pages 398-404, May.
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  14. Robert J. Shiller, 2005. "The Life-Cycle Personal Accounts Proposal for Social Security: An Evaluation," Cowles Foundation Discussion Papers 1504, Cowles Foundation for Research in Economics, Yale University.
  15. James Poterba & Steven F. Venti & David A. Wise, 2007. "Rise of 401(k) Plans, Lifetime Earnings, and Wealth at Retirement," NBER Working Papers 13091, National Bureau of Economic Research, Inc.
  16. Engelhardt, Gary V., 2002. "Pre-Retirement Lump-Sum Pension Distributions and Retirement Income Security: Evidence from the Health and Retirement Study," National Tax Journal, National Tax Association, vol. 55(4), pages 665-85, December.
  17. Andrew A. Samwick & Jonathan Skinner, 2004. "How Will 401(k) Pension Plans Affect Retirement Income?," American Economic Review, American Economic Association, vol. 94(1), pages 329-343, March.
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  19. John Karl Scholz & Ananth Seshadri & Surachai Khitatrakun, 2006. "Are Americans Saving "Optimally" for Retirement?," Journal of Political Economy, University of Chicago Press, vol. 114(4), pages 607-643, August.
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