DB versus DC: a comparison of total compensation

Employer-sponsored pension plans play an important role in providing employees with adequate retirement income. They are expensive and carry some important risks. The employer and its employees share these costs and risks differently depending on the plan design. In this project, two designs are studied, a defined benefit (DB) plan and a defined contribution (DC) plan. They are analyzed in a simple common business setup under the same stochastic economic scenarios generated from a calibrated VAR model. The employer’s total compensation budget is assumed to be constrained so that higher pension contributions are associated with lower salary increases, and vice versa. The two types of plans are compared based on the total compensation, defined as the value of wages and retirement income, received by 25 cohorts of new employees. On an adjusted basis, we find that the two types of plans provide equivalent total compensation to their members.