Retirees with defined benefit pension plans are less likely to draw down their savings to cover their spending than those with a defined contribution plan, according to a new report by the University of Michigan.
It found while most employees born between 1920 and 1940 had access to a DB plan, this percentage dropped dramatically by the time the oldest baby boomers retired, with the youngest boomers — born in 1965 — having almost no access to DB plans.
The report said past generations of retirees with employer-sponsored pension plans barely drew down their financial assets during retirement, likely reserving it for bequests and precautionary savings, rather than spending it to finance their own consumption. It also noted bequests and precautionary medical savings outweigh longevity insurance motives in the explanation of slow drawdown.
Retirees no longer want to equalize consumption between early and late retirement and DB plans provide a relatively larger share of consumption in late retirement, since they guarantee a consumption floor, noted the report. As a result, retirees with a DB plan have less need to save financial assets for late retirement, drawing down faster when they hold more DB benefits and slower when they hold more DC assets.
In an example citing three target retirement ages — 70, 75 and 80 — the report demonstrated a DB plan was associated with higher retention of wealth and retirees with a DB plan drew down their wealth more slowly than those without one.
By age 70, for a household that entered retirement with a DB plan and $200,000 in savings, this slower drawdown is equivalent to having an additional $28,000 remaining at that age, compared to a household with the same initial wealth but no DB plan. Similarly, by age 75 and 80, the household with a DB plan drew down even less, corresponding to $86,000 in retirement wealth.
For retirees without DB plans, the report estimated they’ll draw down 24 per cent of their wealth by age 70, noting at this rate, boomers would deplete their assets by age 85 — roughly the life expectancy for someone who reaches retirement age, leaving them with no precautionary savings for either medical or longevity risk even though roughly half will survive past this age.