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1
Who Chooses Defined Contribution Plans?
Jeffrey R. BrownUniversity of Illinois and NBER
Scott J. WeisbennerUniversity of Illinois and NBER
RRC Annual ConferenceAugust 10, 2006
2
Why care who chooses Defined Contribution (DC) plans?
Numerous proposals to partially replace DB benefits provided by Social Security with personal retirement accounts In many proposals, participation in personal accounts is
voluntary
To assess welfare implications and timing of expenditures of Social Security reform proposals it is important to understand who would opt to participate in personal accounts
3
Our Research Design
Examine a sample of individuals that have to make an explicit choice between DB and DC plans
This choice is important as: Combined employee & employer contributions
are at least 14.6% of wages for these individuals Earnings from this employment are NOT
covered by Social Security
4
Who is our sample?
There are seven states whose public-sector employees do not participate in Social Security California, Colorado, ILLINOIS, Louisiana,
Massachusetts, Ohio, and Texas
We have administrative data provided by the State Universities Retirement System (SURS) of Illinois Established 1941, covers all faculty and support staff of
Illinois higher public education including universities and community colleges
5
Decision faced by SURS-covered employees
Within first six months of employment, are given opportunity to make a one-time, irrevocable choice among three retirement plans: Traditional DB plan: standard formula-based DB plan Portable DB plan: somewhat less generous than
traditional DB if retire from the system, but much more generous if take an early lump-sum distribution
Self-Managed Plan: standard self-directed DC plan If make no decision within 6 months, are defaulted
into the Traditional DB plan
6
Our Focus in This Paper
What choices do individuals make?
What worker characteristics are correlated with retirement plan choice?
7
Brief Background on SURS
Prior to 1998, all SURS employees’ covered by the Traditional DB plan
In 1997, Illinois legislature passed a law allowing participating employees a choice of three plans
These new choices adopted by most employers sometime in 1998
Our sample is 45,000 new hires over period 1999-2004
8
Basics on the three options
Important differences in rate of return, amount of employer matching contributions, handling of “refunds” across the three plans
Vesting period for employer contributions is 5 years
Employee contributions are 8% of salary under all three plans (employer contributions at least 6.6% of salary)
9
Traditional DB Plan
Very generous if are long-tenured employee and retire within the system Annuity retirement benefit is the highest amount
calculated under two different formulas Is NOT generous if leave the SURS system before
retirement and take a “refund” Regardless of vesting status, will receive employee
contributions (plus a 4.5% return) but NOT employer contributions
Is the default option if do not make a choice
10
Portable DB Plan
Retirement benefits from the Portable DB plan are not as generous as those from the Traditional plan for those who retire within the system
Big difference in treatment for those who leave the system before retirement If leave within five years, receive own contributions
(grossed up at an Effective Interest Rate that has been 8-10% over the past 25 years)
If leave with tenure of 5+ years, receive own contributions plus a dollar-for-dollar employer match
11
SMP (DC plan)
Entirely participant-directed DC plan Participants choose from a variety of mutual
funds provided by TIAA-CREF and Fidelity Balance in account depends on asset returns
and vesting status If leave system in less than five years, lose employer
contributions If leave system with tenure of 5+ years, leave with
employee and employer contributions Employer contributions are 6.6% of salary or 0.825-for-
one match
12
Summary
Traditional DB plan a bad deal for short-timers, very good deal for long-tenure employees
Portable DB plan historically offers an attractive rate of return with a larger employer match than the SMP (DC plan)
Plan Choice, 1999-2004
SMP15%
Portable DB19%
Traditional DB66%
Enrollment in SMP (DC plan)
0
10
20
30
40
50
60
70
80
90
100
Full Sample
Enrollment in SMP (DC plan)
0
10
20
30
40
50
60
70
80
90
100
Full Sample UniversityAcademic
Enrollment in SMP (DC plan)
0
10
20
30
40
50
60
70
80
90
100
Full Sample UniversityAcademic
UniversityAcademic
$100K+
Enrollment in SMP (DC plan)
0
10
20
30
40
50
60
70
80
90
100
Full Sample UniversityAcademic
UniversityAcademic
$100K+
Jeff
Enrollment in SMP (DC plan)
0
10
20
30
40
50
60
70
80
90
100
Full Sample UniversityAcademic
UniversityAcademic
$100K+
Jeff Scott
Enrollment in SMP (DC plan)
0
10
20
30
40
50
60
70
80
90
100
Full Sample UniversityAcademic
UniversityAcademic
$100K+
Jeff Scott SURS
DC or DB?
DC
DB Portableor not?
SMP
Portable
Traditional
Framing of Plan Choices
Enrollment in Portable DB Plan
0
10
20
30
40
50
Full Sample University Academic University Academic$100K+
SURS
22
Traditional DB Plan
Is the default plan if no choice made in 6 months Vast majority of Traditional DB plan enrollment is
via the default From 1999-2004, 56% of participants default into the
Traditional DB plan (10% actively choose the Traditional DB plan)
Percent defaulting has grown over time Is the Traditional DB plan the optimal choice for
the defaulters?
Percent of 1999 & 2000 Cohorts that Defaulted into Traditional DB Plan
0
10
20
30
40
50
60
70
Left in < 5 Years Left in 5+ Years Still in System
24
Empirical Findings
More highly educated (university academics) and higher income are more likely to select DC plan
Young workers and those with low income are more likely to default into retirement plan choice
Those that ex post left before vesting more likely to have defaulted into retirement plan choice
Framing of retirement plan choices likely important (DB vs. DC as opposed to 3 plans simultaneously)
25
Next Steps
Missing from administrative data but relevant for retirement plan choice:
Expectations of asset returns Confidence in investment ability Assessment of political risk of DB plan rate of return Tenure expectations Pension coverage of spouse
Currently putting together focus groups (thanks SSA!) to delve into these issues with participants with plans to then administer a much broader survey to shed more light on motivations for pension plan choice