Are 401(k)s more successful than defined benefit plans at replacing income in retirement?

That depends on the definition of success, according to new research from the nonpartisan Employee Benefit Research Institute.

EBRI’s new data incorporates findings from existing studies comparing defined contribution plans’ and DB plans’ efficacy in readying participants for retirement.

It comes on the heels of a widely-publicized report from Boston College’s Center for Retirement Research suggesting 401(k) plans perform on par with pensions when it comes to retirement readiness.

In the CRR study, director Alicia Munnell, an influential retirement expert, backtracked on the Center’s previous thesis—that 401(k) plans were inadequate to defined benefit plans in preparing workers for retirement.

The new EBRI data simulates savings outcomes for workers currently age 25 to 29 who will have at least 30 years of eligibility in a 401(k) plan.

A primary difficulty in comparing 401(k)s to pensions is determining what exactly is a successful income replacement rate, according to the report.

“While there have been a number of attempts to quantify this in the past, there appears to be little consensus on the appropriate levels” of income replacement rates, write researchers for the EBRI.

To account for that, EBRI gauges the plans relative to three income replacement rates: 60, 70, and 80 percent.

It also compares the plans relative to four income quartiles, and assumes Social Security projections as a part of the retirement assets that will replace income.

For the lowest income quartile, defined benefit plans beat 401(k)s for all of the income replacement modeling.

For a 60 percent income replacement rate—low by nearly all industry standards—and assuming a 1.5 percent accrual rate in pension plans, 99 percent of workers stand to replace as much income in retirement with pension assets, while only 86 percent of the lower-income participants in a 401(k) plan will do so.

In fact, at a 60 percent replacement benchmark, pensions beat 401(k)s for all but those in the highest income quartile.

But pensions’ success wanes as replacement rate benchmarks are raised.

Under the 70 percent replacement rate, workers in the top two income quarterlies are resoundingly better off than counterparts in pension plans.

Only 46 percent of workers in the second-highest income quartile can expect to replace 70 percent of income in retirement, compared to 75 percent who contribute to a 401(k) plan.

And when success is measure at an 80 percent replacement rate, 401(k) participants’ advantage is even greater.

For the lowest income workers, pensions and 401(k) plans will yield the same rate of participants achieving an 80 percent replacement rate—about two-thirds, according to the study.

The top three quartiles do much better in 401(k) plans.

In fact, for earners in the top two quartiles, there is virtually no chance of replacing 80 percent of income in defined benefit plans. Whereas 61 percent of workers in the second highest quartile will reach that goal, and 59 percent of the best-paid workers will do so, according to the modeling.

EBRI says the study needs further data. It uses an average growth rate in 401(k) assets of 10.9 percent, which the institute’s proprietary modeling benchmarks show 401(k) plans returned between 2007 and 2013.

Proponents of defined benefit plans would likely challenge that expectation.

The data also does not take into account the effect of automatic escalation, which stands to further benefit 401(k) participants who can afford to participate, the report implies.

Read a copy of EBRI’s findings here.

Followup:

Read: DC vs. DB: 4 views on new EBRI data

Read: VanDerhei defends EBRI autonomy

Instant Insights /

401(k)s beat pensions for higher income replacement rates

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