Money From Defined Benefit Plans Is The Same Color As Money From Defined Contribution Plans

Commentary

Money From Defined Benefit Plans Is The Same Color As Money From Defined Contribution Plans

There is a strange idea floating around the pension world: defined benefit are good for local economies because they provide retirees money to spend and that’s good for economic growth. Well, sure, sort of.

Retirees do spend money, wherever they get it from, and consumption can be helpful for economic growth. (There is an underlying debate here about whether consumption or savings is actually more important for long-term growth, but we’ll set that aside for now.) To the degree that consumption is good for a local economy public sector workers who retire with pensions provided through defined benefit plans will help local economies. But so will public sector retirees with income through cash balance plans, defined contribution plans, or hybrid plans.

However, a recent paper from the National Institute on Retirement Security (NIRS) argues instead that DB plans are better for local economies than DC plans because retirees with DB plans spend their money differently. In a new commentary for Reason.org, my colleague Anil Niraula and I argue that this is a fairly shallow analysis that ignores the following:

  • 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.

Poorly designed DC plans might not fit the above criteria and could lead to scenarios where retirees with income from personal DC plans do spend differently than retirees with guaranteed incomes from DB pensions. But, even in such scenarios that doesn’t lead to a conclusion that DB plans are better for a local economy.

Consider that DB plans could negatively effect a local economy through the growth of unfunded liabilities. As unfunded liabilities have grown, so too have unfunded liability amortization payments, and as the debt payments increase they take up more and more of state and local budgets. In our commentary we conclude:

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.

NIRS has long pushed the idea that DB plans are good for local economies. A fairly standard argument they make is that taxpayers are “investing” in their economies by providing incomes to retirees, who then spend that money back into the economy, and create economic growth. As we discuss in the commentary, this kind of analysis is rooted is some methodologically challenged theories and disregards other potential uses for the taxpayer resources funding the pension plans (such as being spent on other public goods or services, or being left in the taxpayers’ pockets from the start). But it also assumes that money spent by retirees with DB plans differs fundamentally — and measurably — from spending by retirees with other kinds of retirement accounts. And that assumption is just methodologically unsound.

Read the whole commentary here.

Anthony Randazzo

Anthony Randazzo is a senior fellow at Reason Foundation, a nonprofit think tank advancing free minds and free markets.