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NIRS Updates Study on DB Plans Being More Cost-Effective Than DC Plans

On January 6, 2022, the National Institute on Retirement Security (NIRS) released its updated report, A Better Bang for the Buck 3.0: Post-Retirement Experience Drives Cost Advantage for DB Plans over DC Plans. The study found that Defined Benefit (DB) pension plans are significantly more cost-effective than Defined Contribution (DC) plans for providing retirement income. 

This report updates two previous study analyses conducted in 2008 and 2014 comparing DB plans and DC accounts. The new analysis includes two new elements not included in the previous studies: 1) the impact of the current low interest rate environment; and 2) how saving mid-career rather than early career reduces total retirement savings.

According to the report, a typical public sector DB plan has a 49% cost advantage compared to a typical individually directed DC plan. It also indicates that a DB pension costs 27% less than an “ideal” DC plan with below-average fees and no individual investor deficiencies. In addition, 80% of the difference in costs between a DB plan and an individually directed DC plan occurs during the post-retirement period.

The analysis indicates that the primary drivers of cost savings due to DB plans include:

  • Longevity risk pooling– This generates a cost savings of about 7% since DB plans pool longevity risk which enables funding benefits based on the group’s average life expectancy and pay each worker monthly income regardless of how long they live, whereas individuals in DC plans need to save more to protect against living longer than average.
  • Optimally balanced investment portfolios– This generates a cost savings of about 12% since DB plans can maintain an optimally balanced investment portfolio over the long term earning higher investment returns, whereas individuals in DC plans are often advised to shift to lower-risk/lower-return assets as they age.
  • Higher investment returns– This generates a cost savings of about 30% since DB plans generally have higher net investment returns due to professional investment management and lower fees from economies of scale.

The report is available here.