For Performance, 401(k) Plans Can’t Touch Pensions

A new analysis shows that the performance gap in 2011, the most recent year for which research is complete, was the most in almost 20 years.

Pension plans have almost always outperformed 401(k) plans, but the gap in 2011 was the greatest it’s been since the mid-1990s, according to a new report from consulting firm Towers Watson.

Employers are motivated to see that their workers are prepared for retirement so as to enable a smooth transition of the work force. If people can’t afford to retire, employers likely will have to force attrition to happen, one way or another, in order to keep head count at the right level, regardless of potential damage to employee morale or other problems that could trigger.

But companies are not so concerned about their employees’ retirement funding that they’ll contribute as much money to a defined-contribution (DC) plan, like a 401(k), as they did to their former defined-benefit (DB) pension plans. “Our research shows that over the last 17 years, at least, DB plans have consistently outperformed DC plans,” says Dave Suchsland, senior retirement consultant for Towers Watson. “DB plans are actually a less-costly way to provide the same benefit, because the better investment returns mean a company would need to contribute fewer dollars to offer that benefit. But generally when a company moves from DB to DC, it doesn’t provide the same benefit.”

The shift from DB plans to 401(k) plans has been ongoing since 1981. Companies have given different rationales for making the switch: to stay cost-competitive with others in their industry or to pay for rising health-care costs, for example.

Some even suggested that their employees didn’t value the pension plan, preferring a 401(k) or other savings vehicle instead. WellPoint, for example, said employees wanted to decide for themselves how to invest their retirement funds, according to a 2006 article in the Indianapolis Business Journal. At Hanover Insurance Group that same year, the company said its workers “liked the ability to borrow or take withdrawals from 401(k) plans,” according to the Worcester Telegram & Gazette.

Assuming those were accurate representations of employee sentiment, the workers probably changed their minds after the recent recession hammered their 401(k) balances. While the value of most accounts has since recovered, a sense of trust in 401(k) plans likely has not, and there is great yearning within American society for the guaranteed monthly benefit for life that a pension plan brings.

Not that DB plans are a picture of stability. “A DB plan may be even more volatile than a 401(k),” says Suchsland. “But it will typically provide a better benefit than a comparable contribution to a DC plan would provide, because of the advantages of greater diversification, lower fees, and access to investment professionals.”

Towers Watson’s analysis of more than 2,000 employer-sponsored retirement plans found that DB plans had median investment returns of 2.74 percent in 2011, compared to 0.22 percent loss for DC plans. The cause was nothing mysterious; it was all about declining interest rates, which propped up the long-duration, fixed-income investments that DB-plan sponsors have been shifting to over the last several years.

In fact, over the past five years that gap has been narrower than it was historically. Since 1995, DB plans have outperformed DC plans by an average of 76 basis points annually. But in the 2007-2011 period the difference shrank by roughly half, to an average of 39 basis points, driven almost entirely by strong stock-market performance in 2009, when DC plans returned 20.9 percent while DB plans gained 15.5 percent.

Judging by the stock market’s recent stellar performance, when the analysis for 2013 becomes available it likely will show that DC plans once again did better than DB plans, at least for a year’s time.

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