Defining Retirement Plans

A Joint Economic Committee hearing discussed how defined benefit and defined contribution pension plans ensure retirement income and contribute to the economy.

Christian Weller’s testimony before the Joint Economic Committee can be found here.

“These discussions we’ll have today impact the wider economy—whether we’re competitive or not in the world economy, whether we create high-tech jobs, or not. So this isn’t some distant, obscure topic. This is about creating jobs and building an economy here in America,” Senator Bob Casey (D-PA) told the U.S. Congress Joint Economic Committee while introducing Thursday’s hearing, “Your Money, Your Future: Public Pension Plans and the Need to Strengthen Retirement Security and Economic Growth.” Expert testimony at the hearing focused on the use of defined-benefit and defined-contribution pension plans.

In defined-contribution plans, employees can choose to make tax-deductible contributions to a personal retirement fund, which are often matched by their employer. Employees then choose how to invest the money, and face limitations on how and when they can withdraw the money from the plan.

In defined-benefit plans, employees and employers make regular contributions to a large fund, which chooses how to invest the money. Employees participating in these plans are automatically enrolled, and are guaranteed certain retirement income as a result of their participation.

Casey said that under defined-benefit pension plans, employers and employees share the risk, but “by contrast, defined contribution plans allocate all investment risk onto employees.”

Christian Weller, Senior Fellow at the Center for American Progress Action Fund and an Associate Professor of Public Policy at the University of Massachusetts Boston, argued that the defined-benefit plans that many state and local governments currently exemplify are a “model retirement plan” because they provide broad-based, secure coverage for retirement with lifetime benefits, low costs and fees, and professional asset management.

Weller noted that defined-contribution plans require participants to plan for the maximum possible lifespan, while defined-benefit plans allow for risk sharing, and so only require participants to save enough for the average lifespan. He also said that defined-benefit plans consistently demonstrate better investment returns than defined-contribution plans, while incurring lower risk as a result of diversification and uncorrelated investments. Public sector defined-benefit plans offer retirement income at 75 to 80 percent of pre-retirement levels, said Weller, which is well above the retirement income that many with defined contribution plans can expect.

William Pryor, director of the local firefighters union and chairman of the board of investments for the Los Angeles County Employees Retirement Association, noted that “[defined benefit] pension plans are able to make the type of investments that may not be fully realized for as long as 30 years…The investment opportunities in the alternative assets, in real estate, just aren’t in the same universe when you’re involved in a defined contribution versus a defined benefit plan.”

Pryor also said that defined-benefit plans provide adequate incomes to the families of firefighters killed or injured in the line of duty, while 401Ks (a common type of defined-contribution plan) do not. The risk-pooling in defined-benefit plans acts as a type of insurance for injured firefighters, he explained, which is necessary because firefighters’ jobs are so risky that insurers will not cover them.

The hearing emphasized that the virtues of defined-benefit plans extend beyond retirement security. In his opening statement, Casey pointed out that 40 percent of investment in venture capital comes from defined-benefit pension plans, and that this money contributes significantly to the economy by fostering start-ups and growing companies.

Sherrill Neff, a partner in the venture capital firm Quaker BioVentures, testified that 75 percent of his fund’s investment comes from defined-benefit pension plans, and commented, “This is the only pool of capital that is consistently available to us—who are company builders, company creators—with a long-term, multi-decade horizon. And the characteristics of a defined-contribution system are completely anathema to that long-term investment in the economy. So this may be a very good place [for Congress] to do nothing, as it relates to this system.”

Barbara Bovbjerg, the director of education, workforce, and income security at the Government Accountability Office, noted that while public sector defined-benefit plans are doing well, “on the private sector side it’s a much different situation…defined-benefit plans are disappearing.”

To extend these benefits into the private sector, Weller suggested examining “what can be done to promote multi-employer, Taft-Hartley-type pension plans in the private sector which are somewhat similar to the public pension plans as a particular model for private-sector retirement benefit security.”

“I think that [public sector defined benefit plans] serve as a model in terms of how we can achieve retirement security and allow hardworking Americans to achieve a middle-class lifestyle in retirement after a lifetime of hard work,” he said.

Christian Weller’s testimony before the Joint Economic Committee can be found here.

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