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401(k)s Delivering Worse Financial Returns than Traditional Pensions
PSN on September 7, 2006 - 8:25am
In the last few decades, there has been a massive shift from traditional defined benefit retirement plans -- where workers are guaranteed a yearly return in retirement -- to defined contribution plans like 401(k)s where money may be contributed each year with no guaranteed return. The numbers are stark: of workers with pensions (which includes today only 60% of the population), 83% had defined benefit plans in 1980, while only 39% had a defined benefit plan by 2004.
When politicians began promoting 401(k) plans in the early 1980s, the promise was that what workers might lose in guaranteed security, they would make up in higher financial returns in "controlling their own money." Except it hasn't worked out that way.
A just released report by the Boston College Center for Retirement Research (CRR) found that between 1988 and 2004, traditional defined benefit plans outperformed 401(k) plans by a full percentage point. Where defined benefit plans earned 10.7% in annual returns, comparable 401(k) plans earned just 9.7% per year in returns over that same period. Returns for IRAs, for which data is harder to collect, appear to be even worse. Other studies have shown that defined benefit plans outperform 401(k)s by even larger amounts each year -- a difference that adds up to hundreds of thousands of dollars over a lifetime.
A large part of the problem are the much larger fees collected by money managers in 401(k) plans, which undermines long-term returns in those plans. Unsurprisingly, the firms already collecting those large 401(k) fees have been pushing state governments to eliminate defined benefit plans. As the new CRR report highlights, such a move promises only fatter fees for financial firms and lower financial returns for public employees and taxpayers.