Background
The term “Defined Contribution” refers to a prominent retirement savings scheme where the contributions by employees and employers are predetermined and fixed, but the eventual benefits rely heavily on the performance of investments made with those contributions.
Historical Context
The necessity for reliable retirement schemes grew significantly during the 20th century, especially as the number of retirees and life expectancy increased. Employers and policymakers sought sustainable ways to support the growing retiree population, leading to innovations and variants in pension funding.
Definitions and Concepts
Defined Contribution (DC) Pension Plan:
- Contributions: Predetermined amounts contributed by employees and employers.
- Accrued Benefits: The payout is based on the fund’s performance with no guaranteed benefit amount.
- Responsibility: Primarily, individuals bear the investment risk in DC plans as compared to Defined Benefit (DB) plans, where employers take on the risk.
Major Analytical Frameworks
Classical Economics
Analyzes the impact of defined contributions on labor supply and savings rates, with a focus on how shifting financial responsibility to workers may affect their economic behavior.
Neoclassical Economics
Examines the efficiency of markets in determining the optimal investment allocations for defined contribution plans and the impact on consumption smoothing over a worker’s lifespan.
Keynesian Economics
Concentrates on the role of pension contributions and payouts in aggregate demand, especially how fluctuations in fund performance can affect retirees’ spending power.
Marxian Economics
Critiques the system of defined contributions for potentially exacerbating inequality, especially between those with varying levels of financial literacy and access to best-performing investment managers.
Institutional Economics
Provides insight into how institutional structures, such as laws, regulations, and company policies, shape the performance and efficacy of defined contribution plans.
Behavioral Economics
Studies the decision-making behavior of individuals in their pension investments, considering bounded rationality, heuristics, and biases that affect saving and investment choices.
Post-Keynesian Economics
Further focuses on long-term implications for consumer behavior and aggregate demand in the presence of defined contribution systems.
Austrian Economics
Analyses the importance of individual responsibility and choice in managing retirement savings and the limits of governmental or employer interventions.
Development Economics
Views defined contribution plans in the context of developing countries, addressing unique challenges such as informal labor markets and varying institutional capacities.
Monetarism
Investigates how monetary policy and inflation impacts retirement savings growth and the real value of benefits in defined contribution plans.
Comparative Analysis
In comparison to defined benefit plans, defined contribution plans offer more predictable future costs for employers but place the investment risk and variability of outcomes squarely on the employee. This dynamic shifts priority towards financial education and strategic planning for retirement among employees.
Case Studies
Analyses of defined contribution plan outcomes in various countries, workplaces, and demographic groups highlight significant variations linked to investment strategies, market conditions, and participant behavior.
Suggested Books for Further Studies
- “Retirement Heist: How Companies Plunder and Profit from the Nest Eggs of American Workers” by Ellen E. Schultz
- “The 5 Years Before You Retire” by Emily Guy Birken
- “Pension Finance: Putting the Risks and Costs of Defined Benefit Plans Back Under Your Control” by M. Barton Waring
Related Terms with Definitions
- Defined Benefit Plan: A type of pension plan where the benefits retirees receive are calculated using a formula typically based on salary and years of service with the employer, offering more predictable retirement income.
