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Working Paper

Pension Plan Options: Preferences, Choices, and the Distribution of Benefits

Robert L. Clark
WP2003-24

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Abstract — The conversion of traditional defined benefit pension plans to cash balance plans has caused considerable controversy. The primary points of contention have been the reduction in future benefits that older workers had expected and whether cash balance plans violate age discrimination laws. This analysis places the trend toward cash balance plans in the large context of a movement away from traditional defined benefit plans. For the past, 30 years employers have been terminating defined benefit plans and adopting defined contributions while the movement toward cash balance plans has been occurring over the past 15 or 20 years. The paper examines why employers and employees now tend to prefer defined contribution and cash balance plans thus placing these trends in an economic framework. A clear distinction is made between starting new plans where no pension previously existed and the conversion of existing plans. Winners and losers in the conversion process are identified. Throughout the analysis of the distributional effects of plan conversions, it is important to consider what might happen if the conversion was not made. Possible outcomes include the termination of the plan with no new plan established, layoffs, or even bankruptcy of the company. Thus, the impact of plan conversions cannot be determined by simply compared the expected benefits under the old plan conditional on it continuing and the worker remaining with the firm. In summary, the paper concludes that cash balance plans represent a reasonable choice for some firms and some workers while other firms and some workers will prefer traditional defined benefit plans or defined contribution plans. Allowing workers and firms to select from these alternatives will have a higher social benefit than restricting pension choices to a single plan type.