There is a new research paper out from the National Institute on Retirement Security and Milliman that purports to find new public employees are in love with defined benefit (DB) plans. The study looked at public sector plans that offer participants either a DB plan or defined contribution (DC) plan and concludes that around 88% of new hires prefer DB plans to DC plans.
Such a finding is surprising given other research supporting the conclusion DB plans are not as popular for younger workers as they were for previous generations. Younger employees place a premium on mobility, and as the concept of retirement itself becomes more blurred, it makes less sense to have a plan that pays out only after you retire.
Could there be another interpretation of the NIRS-Milliman study?
Well, it turns out that most of the participants considered did not choose either a DB or DC plan, and instead simply stayed with the default option presented to them. In fact, the report finds that anywhere between 40 to 97% of employees were defaulted into the DB plan rather than actively choosing to join (see pages 24 to 31 of the report).
This is a significant methodological point of reference. There is a big different between 88% of new public sector employees actively choosing DB plans over DC plans when presented with the option, and the majority of new public employees making no choice and thus winding up with the defaulted DB option.
Behavioral economics, now in vogue thanks to Cass Sunstein and Richard Thaler’s book Nudge, shows that people tend to stick to the default option when presented with a range of options simply because they’d rather not make the intellectual effort required to make the choice, either by informing themselves on an issue they are unfamiliar with (as is the case with retirement plans) or even by simply considering the options. No matter how trivial the effort required to make a choice is, when they face an option requires an additional effort to choose something other than the default, many will stick with what’s given to them.
This phenomenon, called the default effect, influences decisions in every sphere of human activity, from how we plan for our retirement to whether we’ll ever get around to cancelling that old magazine subscription. In one particularly popular example, the default effect is likely the largest driver of whether or not people will become organ donors after they die, an act of charity that is commonly believed to impose no cost on them other than checking a box at the DMV. (Most experts on organ donation will tell you that changing this default option wouldn’t do much to solve the organ shortage, but the fact remains that many won’t sign up to do something they believe is good if not automatically enrolled.)
Many of the new public sector employees who made no move to change their default retirement choice simply did not find it worth their time to consider—let alone learn about—the options while still others who did do their research were prone to stay with the default option because of the implicit endorsement by their employer.
Thus, in the majority of cases where a defined benefit plan is the default, all we can say with certainty is the number of employees who elected to join the DC plans chose these plans because they felt it was the best fit for their needs. For those who stuck with the default, it’s difficult to say with any certainty how many chose to stick with the DB plan by conscious choice and how many stuck with the default.
Of course, all of the above is analysis assuming that there is adequate information being fairly and objectively presented to new public employees on DB and DC plans. The reality, however, is that unions and professional associations are more likely to encourage individuals join a DB than a DC plan. This is not a problem per se — particularly since a DB plan may be the best choice for some people, and if those people are government employees their representatives are doing their job by recommending a pension. All the same, the outside influences that are close to the employees tend to prefer DB plans for their members, and their influence tends to be stronger than that of those supporting DC plans.
These points only apply to the (potentially large) cohort of workers who wouldn’t have chosen to enroll in a defined benefit plan had they been presented with their options differently. Again, it’s important to note that for some employees, a DB plan is a very attractive option. It guarantees a stream of income that increases the longer you are a member of a given plan. If you plan to spend most of your working life with one employer, this is a good deal. This doesn’t describe the 21st century workforce, who have had an average of five jobs so far in their career. This isn’t surprising for an age cohort where only 40% plan to stay at one place throughout their working career.
Homo sapiens are fickle creatures. We can’t be counted on to apply our full intellectual rigor 100% of the time, even when something as serious as our financial future is at stake. To that end the commentary discussing this research needs to be more responsible in its reporting and avoid using terms like “choose”. Some coverage has been better at explaining this nuance than others, but allof the factors above deserve mention when explaining research examining why employees make the choices they do when it comes to their retirement.
We should also be wary about the impartiality of this analysis. Some of this analysis comes from a place that is clearly biased in favor of defined benefit plans. This isn’t due to malice; many folks believe DB plans are the only secure (or at least the most secure) retirement vehicle. Sure, there are employees for whom a defined benefit plan is the best option, but it’s irresponsible to use the fact that so many new employees are merely not opting out of DB as evidence for the merits of a traditional pension.