The Shift from Defined Benefit to Defined Contribution Plans and Its Effect on Retirement Age
The Shift from Defined Benefit to Defined Contribution Plans and Its Effect on Retirement Age
The Shift from Defined Benefit to Defined Contribution Plans and its Effect on Retirement AgeFIN 4300Dominic PagliaraFor the past 30 years there has been a large shift in pension plans, from defined benefit to defined contribution plans. This shift has led to a later expected retirement age in addition to a lower incentive to retire early. This paper will discuss how and why this happened and what its real effect has been on firms, employees, and retirement.        Before covering the shift from defined benefit (DB) to defined contribution (DC) plans, there must be an understanding of the fundamental difference between the two. In a DB plan, employees receive a monthly benefit after retirement that is calculated using the employee’s wages, years of service, and life expectancy after retirement.  Employees do not (generally) put money into the plan. The burden is on the employer to make contributions to the plan and to calculate what contributions need to be made to ensure that the plan is not underfunded when the employee begins to take distributions from the plan. In a DC plan, fixed contributions are made by the employer and employee. The employee then chooses what to invest his contribution in, whether it be stocks, mutual funds, etc. In doing this, the employee accepts the burden of risk that would have been on the employer in a DB plan. Whatever gain or loss that results from the investment is reflected in the balance of the employee’s individual plan.        The major advantage of a DB plan is the security and stability it provides. No investments need to be made to ensure that there will be the necessary funds at retirement. They can be a major source of retirement income, having been designed to make up nearly 70% of your pre-retirement income when combined with social security. Also, most benefits are insured up to a certain amount by the government through the PBGC (AXA 2013). The downside to these plans is that the employees have no say in what the money is invested in, and because employees cannot choose to invest more in the plan (along with inherent danger of a failure by the plan to vest), they must look elsewhere for additional retirement income.        The major advantage to a defined contribution plan is the flexibility it gives employees to invest their plan contributions however they choose. This allows them to grow their plan and possible future retirement earnings on their own. These plans are also rather advantageous to businesses as they come at a much cheaper price than DB plans. The disadvantage is obviously the loss of the security and certainty that are inherent with a DB plan.        When looking at what has caused this shift from DB to DC plans, it is easy to point at the most obvious of suspects: money. DC plans are simply more financially viable than DB plans. In a packet prepared by Christine Marcks and John Kalamarides of Prudential, they write “from 1998 to 2008,

a reduction in coverage under and benefits provided by DB plans lowered the cost of retirement benefits offered to new, salaried employees by roughly 10%.” (Kalamarides and Marcks, 2011) DC plans are much cheaper to manage and maintain, as the account balance is the benefit and there is no worry about underfunding, overfunding, or imbalance in the assets and liabilities of the plan (van Heijenoort, 2013).While it cannot be argued that the shift saves firms money, it can be argued that it also harms firms and the economy. The Employee Benefit Research Institute (EBRI) reports that 36% of individuals plan to retire after age 65, up from 11% in 1991 (Kalamarides and Marcks, 2011). This 25% swing can affect how companies operate with older employees that may be unable or unwilling to comply with modern business methods or technologies. It can also spike unemployment rates as fewer jobs become open for college graduates due to delayed retirement.        Not all of the reasons for the shift have to do with employers attempts to save money. Another reason is simply a change in the times. When DB plans were especially prevalent, the workforce lacked diversity and the family dynamic was relatively unchanging. Now, with more women in the workforce, single parents, and dual-income families, a plan is required that does not have the rigidity of a DB plan. DC plans offer flexibility to employees because they are tailored to meet individual needs. (Dent and Sloss, 1996)        Also, employers and employees mutually decided on a shift due to the increasing rates of job changing. Because the average employable person expects to change jobs every three to four years, employers see no reason why to cover them under a DB plan. DC plans are more preferable for everyone involved because they transfer across jobs and the account assets are managed by the employees themselves. (SSA, 2009)        Finally, one economic event that cannot be ignored in the study of this shift is the widespread closing of hundreds of industrial plants in the 70’s and early 80’s. Due to these shutdowns, 20 million workers lost their jobs in the region that stretched from Michigan to Massachusetts. These closings and the subsequent ghost towns that became of them caused this region to be renamed the “Rust Belt.” Because many of these workers had been employed by the same plant for decades and the stability of jobs in this new marketplace seemed less than ideal, the idea of a DB plan that was tied to a single employer did not seem enticing. A retirement plan that was more transferrable became very attractive. (Smalhout, 1996)

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Defined Contribution Plans And Pension Plans. (June 12, 2021). Retrieved from https://www.freeessays.education/defined-contribution-plans-and-pension-plans-essay/