Defined Contribution returns sock it to Defined Benefit (for once)
According to the latest pension plan summary data from the Department of Labor (DOL), 2013 was an exceptionally strong year for DC plans, compared to DB. But the longer term pattern continues to point to DB being the more cost-effective system.
2013 bucked the trend
There’s something of a lag between actual experience and the publication of Form 5500 summary data¹ by the DOL, so the latest publication just takes us through 2013. But 2013 was a remarkable year for Defined Contribution plans: an aggregate return of 17.9% represents the best overall result since 1997 (just pipping 2009 by a few basis points.) What’s more, that return was 6.9% higher than the 11% return earned by Defined Benefit plans. That’s only the second time in 15 years that DC has beaten DB, and the margin by which it did so was the largest in at least 24 years (which is as long as we have meaningful data.)
2013 was the best year on record for DC returns compared to DB
It’s not difficult to identify the cause of this big win for DC: in 2013, equity markets rose strongly (the Russell 3000 index delivering 33.6%) while bond markets fell slightly (the Bloomberg US Aggregate Bond index returned -2.0%.) So asset allocation was the big driver of return differences, and DC’s larger allocation to equity led to a strong outcome compared to DB.
DC’s strong performance may come as a surprise to readers who noted the publication last month of the latest in the excellent series of bulletins on this topic by Alicia Munnell and her colleagues at Boston College’s Center for Retirement Research. Their bulletin concludes that it was DB that has outperformed, not DC. That’s partly because that study only used data through the end of 2012. More significantly, the Boston College study looks at longer term numbers. And longer term, DB is still ahead: a dollar invested on January 1, 1992 and earning DB rates of return would by the end of 2013 have been worth $5.39; earning DC rates of return, $4.84. Expressed as annualized returns, that’s 8.0% a year for DB, 7.4% a year for DC.
And the single biggest reason for this difference, they find, is not asset allocation but fees. Even though DC fees have been coming down in recent years and the use of institutionally-priced products is widespread, DC is a more personalized set-up and it’s probably not realistic to expect that fees can be driven all the way down to DB levels.
Not just DB and DC; there’s IRAs, too
The Boston College update is also notable for the analysis it includes of the IRA market. There’s more money in the IRA system than in either the DC system or the DB system, but it’s an aspect of the DB vs. DC story that has not been widely looked at in the past. Munnell and her co-authors find that IRA returns have been well below DC returns—roughly 1% a year over 1990-2012. Part of that difference may be asset allocation (IRAs have a larger average allocation to cash than DB or DC plans) but here, too, they point to fees as having a significant impact.
There are big discussions happening in various places about the overall shape of the U.S. retirement system. Pressure for change is building. But not every change leads to a more efficient system or a more effective one.