Retirement plan type and worker mobility

Evidence of job mobility and plan type

The relationship between job mobility and retirement plan type has been a subject of interest in the economics literature for decades. The early literature on this topic was largely inconclusive, in part because the newness of the DC plans prevented a full examination of differences across levels of tenure. Earlier work on the topic finds no difference in the relationship between job-to-job mobility and plan type; instead, the authors conclude that employees are less likely to leave employers that offer either a DC or a DB plan. A subsequent study finds that employees covered by a DC plan have lower average job tenure than those in a DB plan. This result is at least in part driven by the increased popularity of DC plans over time [4].

More recent research uncovers evidence of a positive relationship between job mobility and participation in a DC plan (compared to a DB plan). In particular, when careful attention is paid to the relationship between plan type, tenure, and job mobility, there is evidence of higher rates of job exit for employees in DC plans relative to those in DB plans among employees with five to ten years of tenure [4]. Evidence from US federal employees also shows higher mobility among mid-career employees after the federal government moved from an all-DB retirement plan to a hybrid plan, consisting of a new DC plan and a lower-payout DB plan [5]. Finding that differences in mobility emerge mid-career suggests that plan incentives may affect mobility. In other words, differences in the incentives for continued employment between the two plans affect employee mobility decisions mid-career, such that a DC plan induces higher mobility than a DB plan.

Alternatively, it is possible that employees with greater expectations for mobility mid-career self-select into employers that offer DC plans (or plans that have a DC component). Hedonic theory proposes that non-wage aspects of compensation can play a key role in affecting the type of employees attracted to an employer. The basic idea is that compensation is composed of wages and non-wage benefits. By making a decision over the mix of wages and non-wage benefits, employers affect the type of employees they attract. In the context of retirement plans, this implies possible differences in the type of employees attracted to employers with a DC plan compared to those with a DB plan based on the employees’ underlying tendency for mobility. Understanding whether and to what extent mobility differences by plan type are due to incentives versus selection is important for understanding whether the introduction of a DC plan causes greater mobility (i.e. incentive effect), or if the DC plan simply better aligns with employees’ existing preferences for mobility (i.e. selection effect).

The authors of a 2017 study directly tackle the question of whether the relationship between job mobility and plan type is driven by selection versus incentive effects using a novel context in which an employer transitions between retirement plans [6]. As part of the transition, existing employees could choose to continue with the original DB plan as their retirement plan, or switch to the DC plan going forward. While the terms of this transition may seem standard, the novel aspect is what occurred if no active choice was made (i.e. plan enrollment if no choice is made): employees below the age of 45 were automatically enrolled in the DC plan, while employees aged 45 or above were automatically kept in the DB plan. An earlier study on the topic finds that these default terms dramatically affect enrollment outcomes; employees who were just younger than 45 had a 60 percentage point higher likelihood of enrolling in the DC plan than employees who were just older than 45 [7].

This dramatic effect of the choice structure on plan enrollment (addressed again later) allows the more recent study's authors to plausibly separate mobility differences due to selection from those due to incentive effects because the default terms induced random variation in plan enrollment between otherwise similar employees [6]. The authors find evidence of positive selection into the DC plan based on mobility tendencies, concluding that at least part of the positive relationship between job mobility and the DC plan found in the literature is likely driven by selection.

Figure 1 shows estimates of how selection into a DC plan (relative to a DB plan) leads to higher job mobility over one-, two-, and three-year time horizons. These findings provide compelling evidence that employee preferences for job mobility contribute to the positive relationship between DC plan offerings and increased job mobility.

Further, the 2017 study finds evidence that the incentive effect of the DC plan is negative, meaning that if existing employees were switched to a DC plan for future accruals without choice, their job mobility would have reduced [6]. While this negative effect is counter to expectations given the structure of DB and DC plan benefits in terms of how they accrue with tenure, this finding highlights the multi-dimensional differences between the two plans. In particular, an employee may find contributions to a DC plan more valuable compared to additional accrual in a DB plan because of the loan and withdrawal provisions typically available for DC plans. In addition, the individual-account aspect of DC plans provides employees with tangible and transparent information on its value (i.e. employees can see the dollar value of the benefit on their account balance statements); this is not the case for DB plans.

Employee valuation of defined benefit and defined contribution plans

Once more referring back to the 2017 study, its findings point to the importance of employee preferences in understanding the relationship between plan type and mobility [6]. At the same time, they raise the question as to how much employees value DB and DC plans. Recent evidence supports the idea that employees may face challenges in gauging the value of DB plan benefits. A study from 2015 investigates how much value employees place on DB benefits in the context of public sector employees (in this particular case teachers) in the US [8]. Using information on how employees responded to an opportunity to purchase additional DB benefits, the author finds that teachers value an additional $1.00 in DB benefits the same as $0.20 in current compensation. This number does not reflect the value these employees place on their full DB plan; instead, it is the value placed on additional DB benefits. The author perceives the low implied value of additional DB benefits as being inconsistent with the view that public sector employees have strong preferences for receiving a substantial part of their lifetime pay in this form of deferred compensation. Other researchers also find evidence that employees place a low value on additional DB benefits [9].

This finding must be placed in the context of other research on the known challenges individuals face in accurately assessing the value of a stream of income, which is called the “annuity puzzle.” A recent study shows evidence of an asymmetry in the evaluation of annuities such that individuals report they are willing to buy an annuity at a price that is much less than they are willing to sell [10]. The difference in price is greatest for those with less education, lower financial literacy, and lower levels of numeracy. The authors conclude that the results are consistent with individuals being “reluctant to engage in an annuity transaction if they have difficulty in ascertaining the value” [10], p. 29. This is likely a contributing factor to the low value employees place on the opportunity to buy additional DB benefits found in the 2015 study.

When examining DC plans, one piece of evidence that may indicate how much employees value DC plan benefits is the participation rate in these plans. Prior to widespread adoption of automatic enrollment provisions, participation rates in DC plans tended to be modest. For example, a 2001 study finds that, prior to automatic enrollment, participation rates at the studied firm were as low as 48% despite a generous matching contribution of up to 6% of the employee's pay [11]. As with DB plans, financial literacy may play a role here, given that many employees—in the US and across other OECD countries—have low financial literacy [12]. One critical component of financial literacy needed to assess the value of contributions made to DC plans is having an understanding of compound growth; this has been shown to be positively related to wealth accumulation at retirement [13].

Limited financial literacy and possible hesitation by employees to engage in decisions about a benefit they may not fully understand has important implications for policymakers and employers considering a transition from DB to DC plans. Namely, the choice structure of a plan transition is likely to have a dramatic effect on plan enrollment outcomes.

Choice architecture and plan transitions

It is now well-established that the structure of a choice environment—including order of choices, number of choices, and which choice is the default—also known as “choice architecture,” has powerful effects on outcomes. While rational models of economic behavior expect such facets of the decision to have minimal effects on outcomes, study after study shows that these features matter in important ways in a variety of contexts, including retirement plans. Research on the powerful effect of default terms in the context of employer-provided retirement plans started with the above-mentioned 2001 study, which finds that switching the choice structure of DC plan enrollment from a traditional opt-in choice to an opt-out choice for employees increases plan participation by approximately 50% [11].

As mentioned earlier, research indicates that choice structure has substantial effects on employee outcomes in the context of an employer transitioning between DB and DC plans [7]. In this research case, the default terms varied based on the age of the employee: the default choice for employees aged 45 or older was to continue in the DB plan as the default selection; alternatively, those younger than 45 were automatically enrolled in the DC plan if no active choice was made. The data show an abrupt jump in enrollment that corresponded with the switch in the default plan: employees who had the DC plan as the default were 60 percentage points more likely to enroll in the DC plan relative to those who had the DB plan as the default. Interestingly, approximately 45% of employees eligible for the transition made an active choice (i.e. filled out paperwork); yet, nearly 70% of those who made an active choice chose the default plan that was assigned to them based on their age. Stated differently, the default terms influenced plan outcomes directly by affecting those who failed to make a choice as well as indirectly by anchoring the enrollment decision among those who made an active choice.