Do Retirees With Defined Benefit Pensions Spend Differently Than Those With Defined Contribution Accounts?

Some Misconceptions About DB Plans

Earlier this year the National Institute on Retirement Security (NIRS) released a report claiming that defined benefit (DB) plans are better for local economies than defined contribution (DC) plans. The argument is rooted in the idea that DB plans generate superior “multiplier” effects on state and local economies through retiree spending. NIRS further argues that because pension checks don’t change during market downturns, DB plans also stabilize local economies in times of financial turmoil. Unfortunately, the NIRS report is full of logical flaws.

Let’s start with a consideration of the report’s methodology.

The NIRS study attempts to “quantify the economic impact of DB pension payments in the U.S. and in each of the 50 states…” using the so-called “multiplier” concept (also known in economics as Keynesian multiplier). The idea is that different kinds of spending influence economic growth in different kinds of ways. Certain expenditures become the income of other people, and other expenditures get reinvested. And to the degree that we can trace the effects of certain kinds of expenditures, as they are multiplied throughout the economy, we can put a value judgment on the efficacy of certain sources of income from the perspective of economic growth. However, whether this can even be done accurately is a matter of persistent debate among economists.

The NIRS authors explain their methodology of calculating the multiplier as dividing the “total output supported by retiree expenditures by total pension payments made in that year.” This poses several challenges for measurement of both the direct and indirect effects of pensioner expenditures. In particular, the analysts would need to know what percentage of benefits received by retirees are actually spent (and not saved), and what kinds of expenditures are being made.

Perhaps even more important for a local multiplier estimate to be made, analysts would need to know whether retiree spending/consumption is done within the state or municipality sponsoring the defined benefit plan or if those dollars are being spent elsewhere — i.e., for the multiplier to be valid, it should only apply to spending that is “captured” locally and is not diverted outside the area.

Given the complexity of such calculations and the granularity of data required, it becomes almost impossible to validate all of the aforementioned estimates without significant simplification.

All pension plans have some data on where their retirees live because they have to pay out the benefits. Thus, doing a more focused study on just one plan might, in theory, reduce the degree of difficulty in this analysis. But even then it is challenging to effectively trace all retiree dollars given the propensity of retirees to travel. And that is all before considering there is no consistent empirical evidence that spending of any kind actually generates more economic income than the amount actually spent.

But assuming for the moment that a multiplier for retiree spending could be calculated, what about the logic of the NIRS argument?

For any given municipal area, whether or not a retiree spending multiplier is greater than one depends heavily on whether retirees stay. There is no means of control on retiree mobility, nor a guarantee that retiree income—no matter the source—will stay in a given local economy. (In fact, this line of reasoning might be better served making an argument that pensions are transfers of resources from taxpayers in colder, northern states to the local economies of warmer, southern states. But at that point the argument is mostly just a commentary on the economic benefits of tourism and demographic mobility.)

Of course, if the analysis is brought up to a national level, this problem for the NIRS paper logic goes away. But another problem replaces it: is there a lot of spending by retirees across the United States? Sure. But that doesn’t say anything about whether defined benefit plans are the necessary source of providing that money to be spent. Whether a retiree’s bank account is fed by checks from defined benefit plans, cash balance plans, or defined contribution plans the money is always the same color. While the authors admit that DB and DC plans are similar in that they deliver comparable retirement benefits, they fail to acknowledge that retirees’ spending may in fact have the same effects on state and local economies regardless of the type of retirement plan they are attached to.

Could consumption patterns of retirees in DB plans be in any way different from those in defined contribution or any other type of retirement plans? The authors argue that because defined benefits are fixed for the retirees and don’t change even during market downturns, then retiree spending patterns won’t change as the result of something like a recession, thereby “stabilizing” local economies. But this analysis ignores that:

  • Cash balance plans and DC plans can be designed to pay out fixed annuities upon retirement just like DB plans;
  • DC plans can have investment strategies tailored to the retirement preferences of the individual; and
  • Well-managed cash balance and DC accounts for retirees will have asset allocations towards safer investments that are explicitly designed to avoid getting hit by market downturns.

Finally, the NIRS paper omits from their analysis a significant consideration for how DB plans might be negatively impacting local economies: as unfunded liabilities for DB plans have grown across the country, required amortization payments have been consuming more and more of state and local budgets. This growth in pension debt cost is crowding out spending on public goods and services, while also making it difficult to reduce tax rates. Even if we assume that a multiplier for retiree spending could be accurately determined and that retirement benefits from DB plans are spent in a meaningfully different way than retirement income derived from other sources, any consideration of how those expenditures influence a local economy would also have to factor in the negative impacts of pension debt in that municipality.

In fact, poor historic investment returns, failure to re-allocate assets given the “new normal” of lower projected future market returns, and troublesome funding policies such as 30-year, level-percent, “open” method of amortizing unfunded liabilities, suggest that DB plans can have serious destabilizing effects too.

The Dallas Police & Fire Pension System knows only too well how generous benefit formulas along with dubious funding practices can hurt the overall solvency of the DB plan, as well as the credit rating of an entire city. Over the last nine years (2007-2016), the plan saw its funded status decline precipitously from 89% to 45%, while unfunded liabilities skyrocketed from $409 million to $3.3 billion. Not only did this directly crowd out an anticipated $800 million bond sale for infrastructure projects, but it also induced plan’s board of trustees to request additional $1.1 billion from city’s taxpayers to balance fund’s liabilities, an amount that approximately equals Dallas’s entire general fund budget. And this is just one recent example showing the limitations and challenges public DB plans face today.

None of this critique requires taking a position on whether DC plans or DB plans are better methods for providing retirement benefits. Instead, our argument is that rather than taking the supposed benefits of DB plans at face value, one needs to consider whether there is any meaningful difference in how DB pensions are spent relative to other retirement plan incomes and be fully aware of DB plan shortcomings. It is quite possible that the net effect of rising pension debt means DB plans are actually hurting local economies more than any supposed economic benefits they might get from retiree spending.

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