Why Do Individuals Choose Define Contribution Plans?

Jeffrey Brown, Scott Weisbenner

NBER Retirement Research Center Paper No. NB 07-01
Issued in September 2007

This paper uses a new survey of participants in the State Universities Retirement System (SURS) of Illinois to determine what factors lead individuals to choose a defined contribution (DC) pension plan over a defined benefit (DB) pension plan, holding all other employment characteristics fixed. In addition to finding that more highly educated and risktolerant participants prefer the DC plan, we also provide direct evidence on five hypotheses about DC pension choice. First, we find that individuals who value “control” over their investments are substantially more likely to choose the DC option. Second, we find that political risk matters: individuals with less confidence in the Illinois state legislature (the body responsible for the current under-funded status of the DB plans) are significantly more likely to choose the DC option (which is fully funded by definition). Third, our results do not suggest that the DC decision is driven by over-optimism of future equity market returns, although we do find that individuals who believe the stock market will provide higher returns than the DB plan are more likely to choose the DC option. Fourth, conditional on beliefs about future returns, investors who rate themselves as average or better than average investors are more likely to choose the SMP than those who rate themselves as worse than average. Finally, we find that a participant's knowledge of plan parameters is quite important, and that a significant minority of participants appear to make decisions based on mistaken beliefs.

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