Last week, a State Senate bill that initially sought to replace New Hampshire’s defined benefit (DB for short — think pension) plan with a defined contribution plan (DC for short — think 401(k)) dissolved into a stalemate. The Senate and House were not even able to form a commission to make recommendations addressing the state’s $4.2 billion in unfunded liability. There seems to be an inability to agree on the facts. We mined a few sources, especially a report from the National Institute On Retirement Security (NIRS), to try to find some clarity.
People assume DC plans are cheaper than DB plans for employers, and therefore for taxpayers — when it comes to public pensions. But that’s not actually true. Economists agree that defined benefit plans are more efficient than defined contribution plans. There are three reasons.
When an employer pools all of their employees’ investments and risks in a single pension fund, they can spread risk over the long term, saving in the good years and spending that in the bad years.
The pooled investments also prevent over– and under-saving, which is what happens with DC plans because individuals can’t predict when they will die.
DB plans have lower management fees because of what economists call “economies of scale.” Like buying anything in bulk, it’s cheaper to manage all of the money at once, rather than managing hundreds or thousands of individual investments.
Because of all of these factors, DB plans provide the same benefit for 46% less than the DC plan provides. Read more…