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Analysis Finds Defined-Benefit Plans Outpace 401(k) Returns

February 5, 2010
Related Topics: Compensation Design and Communication, Retirement/Pensions, Latest News
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Defined-benefit pension plans are consistently earning higher rates of return than 401(k) plans, according to an analysis by consulting firm Towers Watson.

The median annual rate of return from 1995 through 2007 for defined-benefit plans was 10.13 percent, compared with 9.06 percent for 401(k) plans, Towers Watson found.

Towers Watson consultants say it isn’t surprising that rates of return in defined-benefit plans have topped those of 401(k) plans.

Participants in 401(k) plans “often do not optimize their investment strategies. Even with investment education and better default investment options for 401(k) plan participants, DC plans do not replicate all the advantages of DB plans and are unlikely to outperform DB plans, which generally have extended investment horizons and economies of scale,” said Mark Warshawsky, director of retirement research at Towers Watson.

The analysis, which is based on pension plan reports employers file with the federal government, looks at individual years. In 2007, the most recent year included in the analysis, it found that the median rate of return for defined-benefit plans was 7.71 percent, compared with 6.78 percent for 401(k) plans.

The biggest difference during the 13-year period was in 2000, when the median rate of return for defined-benefit plans was -0.01 percent, compared with a 401(k) plan loss of 2.76 percent.

The highest rate of return for defined-benefit plans during the 13 years was in 2003, with a median rate of return of 21.35 percent. During the same period, 401(k) plans registered a 19.68 percent median rate of return.

The top year for 401(k) plans was 1997, when the median rate of return was 19.73 percent, compared with 18.82 percent for defined-benefit plans.

In all, median rates of return for defined-benefit plans were higher than 401(k) plans in nine of the 13 years analyzed by Towers Watson.

Still, despite generating higher investment returns, the number of defined-benefit plans open to new employees continues to fall. As of May 2009, 45 percent of Fortune 100 companies offered a defined-benefit plan to new salaried employees, down from 90 percent in 1998, according to an analysis last year by Watson Wyatt Worldwide prior to its merger with Towers Perrin. By contrast, 55 percent of Fortune 100 companies offered only a defined-contribution plan to new salaried employees last year, compared with 10 percent in 1998.

Employers cite many reasons for moving away from defined-benefit plans. One is  the unpredictability of the amount of required contributions, due to the swings of investment results and interest rates. Another is their concern about future costs as plan participants live longer.

Workforce Management. To comment, e-mail editors@workforce.com.

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