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1 Who Chooses Defined Contribution Plans? Jeffrey R. Brown University of Illinois and NBER Scott J. Weisbenner University of Illinois and NBER RRC Annual.

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Presentation on theme: "1 Who Chooses Defined Contribution Plans? Jeffrey R. Brown University of Illinois and NBER Scott J. Weisbenner University of Illinois and NBER RRC Annual."— Presentation transcript:

1 1 Who Chooses Defined Contribution Plans? Jeffrey R. Brown University of Illinois and NBER Scott J. Weisbenner University of Illinois and NBER RRC Annual Conference August 10, 2006

2 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 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 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 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 6 Our Focus in This Paper  What choices do individuals make?  What worker characteristics are correlated with retirement plan choice?

7 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 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 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 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 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 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)








20 DC or DB? DC DB Portable or not? SMP Portable Traditional Framing of Plan Choices


22 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?


24 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 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

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