Cecily O'Connor
RedwoodAge.com

Participants in defined-benefit pension plans have a better chance of beating the odds in a volatile stock market than 401(k) investors.  

Rates of return for traditional pension plans outpaced those for employee-directed 401(k) plans during the most bull market from 2003 to 2006, according to an analysis by Watson Wyatt Worldwide, a global consulting firm. Pensions outperformed 401(k) plans by 1.7 percent in 2003, 2 percent in 2004, 1.1 percent in 2005 and 1.6 percent in 2006.

The retirement investing landscape is moving away from traditional pensions because employers face mounting pressure to control costs, along with increased regulatory burdens associated with defined benefit plans. Among private-sector American workers who have a retirement benefit at work, about 37 percent have a defined pensions and 63 percent have a 401(k)-type defined contribution retirement plan, according to Employee Benefits Research Institute.  

A defined benefit pension plan promises participants a specific monthly benefit at retirement. Participants generally are not required to make contributions or make investment decisions about the assets. A defined contribution plan provides an individual retirement account such as a 401(k) for each participant. The savings in a contribution plan are based on the amount set aside by the employee and employer, and are also affected by expenses, gains and losses. 

From 1995 to 2006, pensions beat 401(k)s by about 1 percentage point per year during the 12-year period, according to the Watson Wyatt study. That translates into a cumulative dollar difference of nearly 14 percent for money invested at the start of 1995. 

Alan Glickstein, a senior retirement consultant in the firm's Dallas office, wasn't surprised that rates of returns for pension plans are upstaging contribution plans like 401(k)s.

Professional Touch
The professionals hired by employers and public pension funds who manage pension assets "have considerable financial education, experience and discipline as well as access to sophisticated investment tools," Glickstein said. "These advantages, coupled with a much longer investment time horizon, help [defined benefit] plan sponsors maximize their returns and maintain well-diversified portfolios for the benefit of the plan participants."

By contrast, individual investors participating in 401(k)s offered by their employers often lack investing experience and in-depth financial education to choose the appropriate mix of funds. Those shortcomings can reduce rates of return. 

"Individual participants in [defined contribution] plans have more volatile asset allocations over time, as well as a greater range of investment returns, both positive and negative, even within the year," said Mark Warshawsky, director of retirement research at Watson Wyatt. "In an environment where more and more employees have access only to a DC plan, this research underscores the important and continuing role DB [pension] plans play in providing efficient and secure retirement benefits."

The firm's study was based on disclosure data released by the Department of Labor.