Retirement security: Defined-benefit vs. defined-contribution plans

THE APRIL/MAY issue of Public Employee Advocate talked about the “politics of defined-benefit pensions.” Researchers at Boston College set out to answer the question: Why have some states instituted a defined-contribution retirement plan for local and state government employees?

“The most important explanation turns out to be political rather than economic,” according to the Center for Retirement Research at Boston College, which found that states controlled by Republicans are the most likely to introduce a defined-contribution retirement plan for public employees.

A defined-contribution plan is consistent with Republican “political philosophy of individual responsibility for retirement savings,” authors of the report note.

The center looked at 12 states where legislation instituting some form of defined-contribution plan was enacted between 1995 and 2005. The defined-contribution plans in these states fall into three categories: mandatory participation for new hires (Alaska and Michigan); mandatory participation in both defined-benefit and defined-contribution plans (Indiana and Oregon); and defined-contribution option (Colorado, Florida, Montana, North Dakota, Ohio, South Carolina, Vermont and Washington).

While legislative justifications for moving to defined-contribution plans are often tied to the government’s bottom line, the report finds that the employer’s administrative costs for defined-contribution plans are higher. The authors also note that conversion to defined-contribution plans does not solve funding shortages in existing defined-benefit systems. “Although new employees will not accrue any benefits under the old plan, the state must still cover the cost of accrued benefits from past service,” according to the report.

“Moving away from defined-benefit plans means that individuals must face the risk of poor investment returns, the risk that they might outlive their assets, and the risk that inflation will erode the value of their income in retirement,” according to the report. The risk is even greater for the roughly 30 percent of local and state government employees who do not participate in Social Security. Nevertheless, legislatures representing this population of public employees are not deterred by the absence of Social Security’s defined-benefit from instituting defined-contribution plans.

While defined-contribution plans are optional in Colorado and Ohio, where a high proportion of workers don’t participate in Social Security, the defined-contribution plan is mandatory in Alaska, where nearly three-quarters of public employees are not covered by Social Security. Other states with large numbers of state and local employees not covered by Social Security include Connecticut, Illinois, Massachusetts and Nevada.