401(k)s May Result in More Successful Retirement than DBs

Focusing on employees who are eligible for participation in a retirement plan for at least 30 years, the Employee Benefit Research Institute (EBRI) found that a final-average defined benefit (DB) plan with an accrual rate of 1.5% is more likely to provide “successful” outcomes for lower-income workers when the employer-provided retirement benefits are added to the expected Social Security benefits.

However, as income increases, a voluntary-enrollment 401(k) plan has a higher probability of producing a successful outcome than this type of defined benefit plan. A voluntary-enrollment 401(k) plan is even more likely to produce a successful outcome than the final average defined benefit plan when “success” is defined as a real replacement rate greater than 60% of pre-retirement income.

For the analysis, EBRI conducted projections for the percentage of “successful” retirements for 401(k) participants, by income quartile, for those currently ages 25 to 29 in a voluntary-enrollment 401(k) plan. The analysis assumes that workers retire at age 65, and that all balances are converted into an inflation-adjusted annuity at an annuity purchase price of 18.62 at that point. The annual income provided by this annuity in the first year of retirement is added to the simulated Social Security retirement benefit provided for the worker (spousal benefits are not included), and the combined retirement income is expressed as a percentage of the salary the worker was simulated to have earned at age 64. 

For the lowest-income quartile, EBRI found 86% of the workers currently ages 25 to 29 who will have more than 30 years of eligibility for participation in a voluntary-enrollment 401(k) plan are simulated to be able to replace at least 60% of their age-64 salary from their annuitized 401(k) accumulations and Social Security. In contrast, if these same workers (with similar wage and job turnover) are in a final-average DB plan with a 1.5% accrual rate, the probability of “success” increases to 99%. This differential in favor of this specific type of DB plan remains positive for the second- and third-income quartiles (97% vs. 83% and 92% vs. 84%, respectively); however the probability of success is much higher for the highest-income quartile under voluntary-enrollment 401(k) plans (84%) than for the DB plan (57%).

When the definition of “success” is a 70% pre-retirement income replacement, the lowest-income quartile still has a higher probability of success with the DB plan, and the second-income quartile has a slightly higher probability of success with the DB plan, but the third- and highest-income quartiles have a higher probability of success with the 401(k) plan.

Finally, defining “success” as replacing 80% of pre-retirement income in retirement, the analysis found the 401(k) plan has a much higher probability of success than the DB plan for all groups except the lowest-income quartile, for which the probability of success is virtually even for the 401(k) and the DB plan.

EBRI notes that a recent analysis from the Center for Retirement Research at Boston College found the shift to workers mostly being covered by defined contribution (DC) plans rather than DBs has not resulted in less retirement savings.

EBRI’s full report is published in the October 2015 EBRI Notes, “How Does the Probability of a “Successful” Retirement Differ Between Participants in Final-Average Defined Benefit Plans and Voluntary Enrollment 401(k) Plans?” available online at www.ebri.org.