Policy Documents

Defined Benefit and Defined Contribution Retirement Plans

John S. Howe –
December 22, 2010

The mission of the Show-Me Institute is: “Advancing liberty with responsibility by promoting market solutions for Missouri public policy.” This study addresses an important issue with implications for public policy: retirement plans. It compares defined benefit (DB) and defined contribution (DC) retirement plans in order to assess whether the recent trend toward DC plans is, on balance, beneficial to workers. It further identifies policies — both public and private — that would make retirement plans more effective, with the goal of advancing liberty and responsibility. DB plans are characterized by a higher degree of certainty for plan participants than DC plans, but have a lower average rate of return. DC plans offer more choices to workers, and thus are generally preferable. If a worker prefers the lower risk and lower return of a DB plan, most DC plans include investment options that enable that outcome. However, some workers enrolled in DC plans make suboptimal choices, raising the question of the proper role of the company and of government in influencing those choices. To what extent should we allow people to make bad decisions? What if the consequences of those decisions fall on innocent third parties? Public and company-level (“private”) policy can range from abstaining from intervention of any sort to mandating that workers make certain choices. This study examines these extremes, as well as one type of middle path between them.