Pension reform: alternate retirement plan helps governments escape the debt spiral
Reforming Pensions: A Short Guide, by Nicholas Barr, 2009.
Governments can offer retirement plans that don’t require lifer status—the defined benefit pension, after all, shortchanges employees who seek career-mobility. Instead, a defined contribution plan can deliver retirement security while breaking taxpayers out of unfunded liabilities. Reason Foundation’s Zachary Christensen writes how the “DC choice” helped Utah improve its funded status.
The most common retirement offering for public workers comes in the form of a defined benefit (DB) pension, but shifts in employee behavior suggest a need to modernize this approach for new hires. With changes in workforce mobility, government employers must expand their offerings beyond the traditional pension plan to appeal to a broader range of career paths. An increasingly popular and effective way to do this is by adding an optional defined contribution, or DC choice, plan that new workers can select at the beginning of their employment.
An examination of how benefits accrue differently between these two options shows that one type of plan can work better, depending on factors like age of hire and years of service. The best way to accommodate all workforce situations is to allow each new worker to select the option that they believe best works for them. In most cases, an educator hired at 25 is only better off after full retirement when compared to a defined contribution plan. Before full retirement, that teacher will likely only get about 70% of the benefit they would have gotten in the DC plan.
Choice plans—plans that give the option to choose between a defined benefit or defined contribution plan at the time of hiring—are beneficial not just for the employee but can also benefit the employer. With the proliferation of unfunded public pension liabilities among U.S. governments, optional defined contribution plans can serve as valuable risk mitigation solutions. For example, Utah significantly improved its funded status after implementing a DC choice system in 2012.
…setting DC contribution rates to match the pension plan can lead to contributions misaligned with the DC’s primary objective and is not a wise idea. In the past, this approach created challenges for Florida’s public employee retirement plan, which was eventually addressed with a realignment of DC contribution rates.
The Michigan State Employee Retirement System, MSERS, set the rate for its optional DC plan around best practices for retirement security, which, in this case, provided employees with an incentive to choose the DC option.
Read the whole thing here.
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