Cecily O'Connor
RedwoodAge.com

As the market soared to new heights and plunged to frightening lows in 2007 and 2008, some retirement plans came through the storm a bit less bruised than others.

Defined benefit pension plans, which promise a specific monthly payment after retirement, beat 401(k) returns by almost 1 percentage point in 2007 and 2008, according to a new report.

Participants in 401(k) plans were less likely than DB plan sponsors to rebalance their asset portfolios while stock values ran up, leaving them more vulnerable to market declines, said Mark Ruloff, senior consultant at Towers Watson, a firm that provides benefit advice to corporations.

“Many DB sponsors had been reducing their exposure to equities and already shifted toward more conservative investment strategies in 2007, which helped to mitigate their losses," he said.

In spite of pensions coming out ahead, both types of plans did lose value during that two-year period, thanks in part, to the unfolding US economic crisis, according to the analysis. The DB  plans reported a median loss of 25.27 percent in 2008, while defined contribution (DC) plans - a category that includes 401(k)s - had  a median loss of 26.20 percent. That is based on data from 79 companies that sponsor both plans.

While the difference  may not sound like much, in a retirement account with $200,000 in assets, the difference is about $1,860.

The 2007 returns, drawn from broader analysis of more than 2,000 plan sponsors, show that DB plans had a median return of 7.71 percent, while DC plans had a median return of 6.78 percent - another $1,860 difference for a $200,000 account.

This finding is consistent with earlier data, which show that DB plans have consistently outperformed DC plans by an average of about 1 percentage point per year during both bull and bear stock markets, Towers Watson reported.

Hard to 'Replicate' DB Advantages
Traditional DB pension plans have been around for decades as part of the retirement savings family, but have become somewhat of an outcast as companies increasingly rely on cheaper-to-administer 401(k) plans. In general, larger pension plans can afford to spend more on professional money managers to oversee plan assets and employ more sophisticated, cutting-edge investment strategies. 

A DB plan promises a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, or it may determine a benefit through a plan formula that factors in salary and years of service. 

But as the US economy has struggled in recent years, both large and small employers have frozen their professionally managed DB programs, citing the need to cut costs. As a result, more workers have been investing their retirement in 401(k) plans. While 401(k)s come with advantages such as the flexibility to port that money from job to job, workers still often forget about routine maintenance to their account to make sure it's well balanced. 

Performance Gap
"Even with more investment education and better default investment options for 401(k) plan participants, DC plans do not replicate all the advantages of DB plans and are unlikely to outperform DB plans, which generally have extended investment horizons and economies of scale," said Mark Warshawsky, senior retirement researcher at Towers Watson.

Additionally, while most DB plans incurred losses for 2008, some actually reported small positive returns. By contrast, all DC plans in the study had losses of at least 10 percent, and a few had losses greater than 40 percent, which is more than any DB plan in the study.

The analysis also found that, between 1995 and 2007, larger DB and DC plans blew past the performance of smaller plans. During this 12-year period, the largest sixth of DB plans outperformed the smallest sixth by approximately 3 percentage points. In contrast, the largest sixth of DC plans beat the smallest by approximately 0.7 percentage points.

Towers Watson consultants attributed that outperformance to the adoption of several investment strategies. That includes alternative investments - such as real estate and private equity - which tended to fare better than stocks in the recent market downturn. DB plan sponsors also began investing pension assets in a way that their movement would more mirror pension liabilities, or the expected retirement benefit benefits.