Recently, a group of Houston millionaires announced that they would soon be initiating a campaign to eliminate traditional pensions for Texas teachers, fire fighters, police officers, and other state and local government workers. They said that they are taking this action to protect taxpayers. But a recent report by the National Institute for Retirement Security finds that traditional pensions, also known as defined benefit pensions, “are a cost-effective way to fund a retirement benefit” that “serve employees, employers, and taxpayers well.”
The study conducted by Mark Olleman, an actuarial consultant, and Ilana Boivie, an economist, finds that switching from traditional plans to defined contribution plans such as 401(k) plans as advocated by the millionaires costs taxpayers more than retaining traditional pensions and does not address the unfunded liability issue, usually the reason given for making the switch.
The study also finds that public employees prefer traditional pension plans, that traditional pension plans have a higher rate of return on investment, and that many people with defined contribution plans will exhaust their savings before they die.
In addition to not providing adequate benefits, defined contribution plans, according to the study, don’t save state and local governments any money. States and local governments can’t switch workers in a traditional plan to defined contribution plan, so they have to operate two retirement plans, one for new hires and one for those already working. Operating two plans doubles the administrative costs, thus requiring “far greater contributions from both employers/taxpayers and employees.”
Traditional pension plans, the study concludes, are the most cost efficient way to provide a pension benefit. A traditional plan “can provide the same retirement benefit at half the cost of a defined contribution plan.”
To arrive at these findings the study examines seven state pension plans that give employees the choice of choosing a traditional pension or a defined contribution plan. The study also describes the experience of West Virginia and Nebraska, two states that replaced traditional pension plans with defined contribution plans and have since discontinued this practice.
West Virginia in 1991 made all newly hired teachers enroll in a defined contribution savings plan instead of the teachers’ traditional pension plan. But by 2003, the state reconsidered its decision because those enrolled in the defined contribution plan achieved a much lower rate of return than anticipated, making retirement for many much more difficult.
In addition, switching to a defined contribution plan did not eliminate the state’s unfunded liability and cost more than anticipated. An unfunded liability is the difference between a pension fund’s total assets and its liabilities estimated over a 30 year period. A fund with an unfunded liability of 80 percent is considered to be sound.
West Virginia hoped that by switching new teachers to a defined contribution plan, it could improve its unfunded liability. But that turned out not to be the case. It also projected that it would save $1.2 billion over 30 years by switching newly hired teachers to defined contribution plans, but the savings never materialized.
In 2008, teachers in the defined contribution plan were given the choice of switching to a traditional plan. As a result, 78 percent chose the traditional plan, including 76 percent of young teachers, many of whom might be expected to prefer a defined contribution plan.
Nebraska has had even more experience with defined contribution plans. In 1963, state and local government employees were moved into a defined contribution plan. The state’s teachers remained in a traditional plan. Between 1982 and 2002, the average rate of return for the traditional pension plan was 11 percent. For the defined contribution plan, it was between 6 percent and 7 percent.
As a result, those in a defined contribution plan could expect to receive only 30 percent pre-retirement income, far below the 50 percent to 60 percent that had been projected. Consequently, Nebraska decided in 2003 to enroll new hires in a traditional cash balance pension plan.
Finally, the study says that traditional pension plans are “an effective retention tool” that help state and local governments attract and retain a well-qualified workforce.