How Has the Shift to 401(k) Plans Affected Retirement Income

Employer-sponsored retirement plans have shifted dramatically in recent decades from defined benefit (DB) to defined contribution (DC) plans. Although theoretical calculations show that participants in 401(k) and other DC plans who stay the course can accumulate substantial account balances, many studies have documented how such plans often fall short. This shortfall reflects a failure of workers to participate, inadequate contribution rates, leakages, poor investment choices, and subpar market returns. On the other hand, while DB plans provide generous benefits for workers who spend most of their career with a single employer, the pensions of job-hoppers are eroded by inflation and those who separate prior to vesting receive nothing. Therefore, the net effect of the shift from DB to DC plans on retirement wealth and income is unclear. This brief, adapted from a recent paper, uses the Health and Retirement Study (HRS) to document the amount and distribution of retirement wealth, the amount of retirement income it produces, and the pattern of replacement rates for households ages 51-56 in 1992, 1998, 2004, and 2010. The discussion proceeds as follows. The first section describes the data and presents trends in retirement plan coverage. The second section explores whether workers in 2010, when DC plans dominated, had more or less retirement wealth in employer plans than their counterparts in 1992, when DB plans dominated. It also reports how that wealth was distributed by education. The third section shifts the focus from wealth to income. It shows the impact of moving from DB plans, where annuities are actuarially fair, to DC plans, where annuities must be purchased on the open market; and it examines the pattern of replacement rates over time. The final section concludes with four observations. First, retirement wealth has been relatively steady or declining, depending on whether the starting year is 1992 or 1998. Second, DC wealth is more concentrated in the top quartile of education than DB wealth, and this concentration will become more evident in the aggregate wealth measure as the shift from DB to DC plans evolves. Third, the shift from DB to DC has reduced the amount of retirement income per dollar of wealth because DC participants have to pay more for annuities, and annuity rates fell as interest rates dropped. Fourth, even with later retirement ages, steady retirement income combined with rising wages has produced declining replacement rates. Thus, retirement income from employer plans has been contracting.