Consider an employer replacing a defined benefit (DB) plan (a.k.a., traditional pension plan) with a defined contribution (DC) plan. All new employees will be covered by the DC plan; existing employees will have a choice whether to continue to accrue benefits in the DB plan, or switch to the DC plan. Which existing employees will switch plans? How might the change influence an employee’s job mobility decision?
The connection between job mobility and employer-provided retirement benefits has been repeatedly examined over the past several decades. A dramatic increase in the prevalence of DC plans along with a decline in DB plans, and a decrease in rates of long-term employment make this connection interesting. Differences in the benefit structures of these two retirement plans suggest an apparent link: DB plans often reward long tenure, while contributions to DC plans are typically independent of tenure. The weakened incentives for long-term employment in DC plans may have caused the decline in long-term employment.
Recent research challenges this conventional thinking, finding evidence that DC plans may reduce employee mobility. One such study examined a specific example, seeking to estimate the “incentive effect”—the effect of plan incentives on employee mobility—separate from the “selection effect.” The idea of the selection effect is that the causal link between plan type and mobility runs in the other direction: employees who choose a DC plan have higher underlying mobility tendencies. Therefore, the decline in long-term employment results in an increase in demand for DC plans.
Separating the incentive and selection effects is a challenge. To overcome this challenge the researchers exploited the variation in plan choice induced by how the employer structured the default plan (i.e. the plan that was assigned if an existing employee failed to make a choice). Namely, for current employees under the age of 45, the default plan choice was DC, while for current employees 45 or over, the default plan was the DB plan. This default structure had a dramatic effect on plan choice.
Leveraging this variation, there is evidence of positive selection into the DC plan based on mobility tendencies. At least part of the positive relationship between job mobility and DC plan is driven by selection. Further, the incentive effect of the DC plan is negative, meaning that if you switched existing employees to a DC plan without a choice, these employees would experience a reduction in job mobility.
This negative effect of DC plan on mobility is counter to prior work that emphasizes plan differences in benefit accrual with tenure. Instead, this finding highlights the fact that DB and DC plans differ in additional dimensions. An employee may perceive contributions to a DC plan as more valuable compared to accruals in a DB plan because of the loan and withdrawal provisions available in DC plans. In addition, employees have more tangible and transparent information on DC benefits’ value through quarterly balance statements, which is not the case for DB plans.
An important caveat to this finding is that these existing employees were considering a switch to a DC plan for future benefit accruals. The existing DB plan was left intact. Therefore, we cannot generalize these findings to situations where a DB benefit is wholly replaced by a DC benefit. Stated differently, this conclusion cannot be applied to the question of replacing a publicly provided pension, such as Social Security, with a system of individual accounts. Instead, these findings are most relevant to employers considering altering their retirement plan.
© Colleen Flaherty Manchester
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