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
1
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
2
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
3
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
4
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
5
Our Focus in This Paper
 What choices do individuals make?
 What worker characteristics are correlated
with retirement plan choice?
6
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
7
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)
8
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
9
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 810% over the past 25 years)
If leave with tenure of 5+ years, receive own
contributions plus a dollar-for-dollar employer match
10
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-forone match
11
Summary
 Traditional DB plan a bad deal for shorttimers, 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)
12
Plan Choice, 1999-2004
SMP
15%
Portable DB
19%
Traditional DB
66%
Enrollment in SMP (DC plan)
100
90
80
70
60
50
40
30
20
10
0
Full Sample
Enrollment in SMP (DC plan)
100
90
80
70
60
50
40
30
20
10
0
Full Sample
University
Academic
Enrollment in SMP (DC plan)
100
90
80
70
60
50
40
30
20
10
0
Full Sample
University
Academic
University
Academic
$100K+
Enrollment in SMP (DC plan)
100
90
80
70
60
50
40
30
20
10
0
Full Sample
University
Academic
University
Academic
$100K+
Jeff
Enrollment in SMP (DC plan)
100
90
80
70
60
50
40
30
20
10
0
Full Sample
University
Academic
University
Academic
$100K+
Jeff
Scott
Enrollment in SMP (DC plan)
100
90
80
70
60
50
40
30
20
10
0
Full Sample
University
Academic
University
Academic
$100K+
Jeff
Scott
SURS
Framing of Plan Choices
SMP
DC
DC or
DB?
Portable
DB
Portable
or not?
Traditional
Enrollment in Portable DB Plan
50
40
30
20
10
0
Full Sample
University Academic University Academic
$100K+
SURS
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?
22
Percent of 1999 & 2000 Cohorts that
Defaulted into Traditional DB Plan
70
60
50
40
30
20
10
0
Left in < 5 Years
Left in 5+ Years
Still in System
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)
24
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
25