Over the last 25 years, we have witnessed the shift in retirement plans in the private sector from defined benefit (DB) to defined contribution (DC). While we acknowledge this extreme reversal in the retirement landscape, we question its stability in the long run because of longevity risk from the perspective of the retiree.
Longevity risk from the DB plan sponsor's perspective is that the pensioners live beyond what is predicted by actuarial assumptions. The DB plan sponsor (or insurance company writing annuity business) finances the risk associated with the range of life expectancy. This risk, in part, underlay the shift to DC plans.
Longevity risk from the perspective of the retiree is defined as the risk of running out of money during retirement. Having benefits from a DC plan as a primary retirement source subjects plan participants to their own longevity risk. Based on average life expectancy statistics, we know that half of the population will survive beyond its life expectancy and half of the population will not. This creates challenging circumstances for people to manage withdrawals from their retirement accounts. In addition, there is the added challenge of managing investments.
This article explores a new retirement paradigm where both types of plans can coexist and complement one another. This new retirement paradigm will recognize the existing DC plan as the primary retirement vehicle and view the DB plan as a secondary plan sponsored by private sector employers.