The Defined Contribution Paradigm

Abstract

Pension cognoscenti have frequently remarked on the stagnation of defined benefit pensions and the concomitant rise of defined contribution plans. I suggest that, over the last generation, something even more fundamental has occurred, something that can justly be called a paradigm shift. Americans today primarily conceive of and implement retirement savings in the form of individual accounts. Such accounts have become primary instruments of public policy, not just for retirement savings, but increasingly for health care and education as well. Pension mavens have framed the choice between the defined benefit and the defined contribution formats as a matter of risk allocation in the design of retirement savings programs. However, the defined contribution society as it has emerged today entails more considerations than this and constitutes a fundamental transformation of the way Americans think about and implement tax and social policy. The initial Part of this Article describes the differences between defined benefit and defined contribution plans as retirement savings devices. Part II discusses these differences as a matter of retirement plan design: Defined benefit arrangements principally allocate risk and reward to the sponsoring employer, while defined contribution devices assign such risk and reward to the participant. In the third Part, I sketch the major features of the contemporary defined contribution paradigm and its development to date. This sketch highlights, inter alia, the extent to which the paradigm today determines how middleclass individuals and households undertake their medical and educational savings, making the defined contribution format the norm for such savings. The fourth Part places the defined contribution paradigm in the context of the possible futures of the Internal Revenue Code and emphasizes the extent to which the paradigm has effectively converted the Code into a consumption tax for middle-class taxpayers. Finally, I label the choices presented to us by the defined contribution paradigm and identify those that I think are best.