Essay Example on Contributions to Defined Contribution Pension Plans

Over the past several decades, defined contribution (DC) pensions, have greatly increased in popularity among numerous persons in society. This is as compared to the defined benefit (DB) pensions, which was the methodology previously used for centuries to formulate the retirement packages for persons in different societies around the world. The greatest reason why the DC contribution choices have become remarkably popular is because of the substantial discretion that the beneficiaries have over the amount they contribute to their DC pension. This essay is a critical summary of an article published by the National Bureau of Economic Research that discussed the contributions to DC pensions plans detailing the description of the article and an opinion about the content of the article.

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Description of the Publication

According to James J. Choi, the study of DC contribution choices can offer the general insights into the various determinants of personal economic decision-making (Choi, 2015). The detail of the findings recorded in the article proved that the DC pension system greatly deviated from the various numerous predictions of the classical frictionless optimizing models. The article provided an overview of the U.S. DC pension system, but analyzing the factors that affect the premium contributions of DC pension system in the nation. Such factors include the employers matching contributions, active choice deadlines and the automatic enrollment of the public members in the U.S. to the DC contribution system. In addition, the article also details the choice overloads, personal experience on individuals DC contributions, mental accounting, financial literacy as well as peer effects in response to DC contributions (Choi, 2015).

Under the factors of matching contributions, according to the article, numerous employers in the U.S. make a matching contribution for their employees 401(k) and 403(b) contributions (Choi, 2015). This is when making premium contributions for their employees direct contributions. The common formulas used by the employers include both a single-tier formula and multi-tier formulas. An active choice enrollment plan gives the employees a chance to choose their own contribution rate as well as a contribution default. According to the article, a significant number of employees in the U.S. have an active choice enrollment option, which they use for their contributions with the DC pension system. The automatic enrollment option is the striking characteristic of the 401(k) U.S. employees DC pension contribution system (Choi, 2015). At this point, the employees contribution rates are at their high level of inertia, in their status quo (Choi, 2015). According to the article, changing the status quo of the employees can greatly affect their DC pension contributions in a large way.

The article also talks about a choice overload as a factor affecting the DC pension system in the U.S. employment sector. It is an alternative that can be employed by pension contributors to overcome inertia (Choi, 2015). According to the publication, having an active choice for opting out of a contribution default greatly affects the contributions made by employees using the DC pension system. According to the choice overload factor, there are no monetary costs that can be incurred in opting out of a premium pension default. Nevertheless, there are cognitive costs associated with figuring out the choices to opt out to, or the logistical efforts costs of the opt-out process (Choi, 2015). The other factor affecting the choice of pension systems to select in the U.S. is the low financial literacy levels among the majority significant proportion of the U.S. employment sector. According to Choi (2015), financial literacy amongst the employees in the nation greatly reduces their cognitive costs of forming active contribution choices of their pension systems.

The aspect of peer effects is also a factor affecting the choice of pension system adopted by employees in the U.S. According to the publication, during the choices of the pension system, peers exhibit similar behaviors not because of mutual influence but because of sharing a common observable factor (Choi, 2015). The article enlightens that workers working with the same department or level can immensely influence each others choices of a pension system. The final factor that affects the choice of a pension system by the U.S. pension contributors is the mental accounting. This is an instance where all the employees of an organization are forced to make a mandatory contribution to a DC pension plan (Choi, 2015). In this methodology, a portion of such contributions is referred as the employer contribution while the remaining amount is characterized as the employee contribution. This phenomenon can be evidenced in numerous universities in the nation, where all staff members are supposed to contribute a retirement package to a DC plan (Choi, 2015).

Opinion Pertaining the Article

The article has comprehensively detailed the factors that affect the choice of the DC premium system by most people in the United States. It has also substantially detailed why the DC pension system has greatly become the popular choice of retirement package as compared to the DB pension system that was used since centuries ago. The article has offered efficient statistical findings pertaining the proportionate percentage volume of the level of different pension systems in the U.S. It has greatly supported the DC plans as the best selection by illustrating the different problems facing the choice of this pension system and probable implied solutions to circumventing the issues.

References

Choi, J. J. (2015, August ). Contributions to Defined Contribution Pension Plans. Annual Review of Financial Economics, 7(21467). doi:DOI: 10.1146/annurev-financial-111914-041834