Defined benefit pension plans would need median accrual rates of 1 to 3 percent of final compensation for each year of participation to provide retirement income equal to voluntary enrollment 401(k) plans.
A study by the nonpartisan Employee Benefit Research Institute found that these rates would go down if investment returns fell and annuity prices went up between 0.6 to 1.6 percent per year.
EBRI conducted research on how generous a traditional pension plan would have to be to produce as much retirement income as a 401(k) plan.
EBRI used different simulation models for the study that varied gender and the ways people could turn their retirement savings into income, either by annuitizing their defined contribution plan or rolling over an individual retirement account. Group members analyzed for the study were currently between the ages of 25 and 29.
Financial planners usually look at current 401(k) balances to project future retirement income, but defined benefit design outcomes are often taken at face value, or the amount the plan design would provide—assuming that full service and vesting requirements are fulfilled, according to the report’s author Jack VanDerhei, EBRI research director.
EBRI’s report builds on an earlier modeling analysis, using a stylized final average DB accrual of 1.5 percent of final compensation per year of participation, to compute the retirement income at age 65, across a range of tenure and income factors. It compares the outcomes with the projected sum of 401(k) and IRA rollover balances, expressed as the value of an annuity each benefit would produce, to provide a reference point in evaluating the two plan designs.
It is hard to compare the two retirement vehicles because there are major structural differences between them and how they function. There also are extreme variations in the respective job tenure of American workers and factors that affect each plan differently, including investment market returns and annuity purchase prices.