Why traditional government pension plans don’t work for today’s new employees 

If the purpose of any retirement plan is to contribute proportionally to a lifetime income for a participant after a career ends, then the plan’s design must recognize the reality of employment patterns among workers. The pension plan for an employee hired a generation or two ago need not be the same design as a retirement plan for an employee hired today. And given the dramatic changes in employment patterns over the past few decades, the plans should not be the same. 

To modernize retirement offerings to the workers the government hopes to attract today, government leadership and policymakers first need to clearly establish what they are trying to achieve. Anchoring to a retirement benefit that adequately advances the ultimate retirement security of all new hires is an objective that likely all stakeholders can agree upon. It’s a much better approach than merely sticking to an old plan design without considering what government employers want to get out of an employee retirement plan. 

As the last bastion of traditional defined benefit (DB) pensions, state and local government plans have not, by and large, adapted to meet the needs of changing workforce patterns. While reforms to these public pension plans have been numerous and ongoing, most reforms have primarily focused on shoring up financials rather than better meeting the needs of employees.

There are exceptions, of course. For example, the Arizona Public Safety Retirement System modernized its retirement benefits, and lawmakers enacted similar reforms for Michigan teachers. Unfortunately, most policymakers are usually focused on finding ways to pay for unexpected pension costs rather than reshaping retirement benefits to meet the evolving needs of today’s public workers. 

There has also been extensive debate over many years about what type of retirement plan is optimal for state and local governments to maintain. While there are valid points to be made for various plan types, it has become increasingly clear that only offering the ubiquitous traditional pension in the state and local governmental world is the wrong choice going forward. 

The data provided by the retirement systems themselves bears this truth out unambiguously. The following chart, compiled by the Pension Integrity Project at Reason Foundation, uses data from the Annual Comprehensive Financial Reports (ACFRs) of a selection of public retirement systems. The pension systems represented in this chart are geographically diverse across the country and were selected by Reason Foundation to represent both teachers and general public employees. The chart shows the probability of an employee remaining in each pension plan for any number of years following initial employment at the age of 30. 

There are several important takeaways from this data.   

• With variations in percentages, the pension systems are reporting almost identical retention curves.  As Reason Foundation compiles more system-provided data, the results will likely mirror those here. There will be outliers, with both better and worse retention experiences, but the consistency of experience is clear. 

• Of the 11 plans represented here, the probability of remaining in the plan at five years of employment ranges from a high of 58% to a low of 28%. At 10 years, the probability drops to 44% at the high and 17% at the low end. The probabilities continue to drop steadily even after that point. 

• Most employees will not remain in their state and local governmental pension plan long enough to become vested in future benefits. For those who do achieve full vesting but leave before reaching retirement, their ultimate income benefit will be based on their age, salary, and years of service when their employment is terminated with that system. This benefit will be further eroded by inflationary effects over the period during which the money was not working for the plan participant. 

The primary takeaway is clearly that if the objective of the state or local government’s retirement plan is to provide secure lifetime income for the portion of an employee’s career spent at that governmental entity, then a retirement plan that recognizes modern employee mobility must be offered. The traditional defined benefit pension is not that plan design. It was effective when remaining with one employer for a full career was common and desired. That’s no longer the case for most workers. 

Several government-run retirement plans—but far too few—have begun to adopt modernized plans that reflect the needs of a more mobile population of public workers. North Dakota recently adopted a defined contribution (DC) retirement approach for new hires, which gives state teachers and employees flexible individual accounts that they can take with them with no penalty in the increasingly probable chance that they will move on to another job within five to 10 years.  

Many states have found success in giving their employees multiple options, which allows new hires to choose which type of plan best suits their unique situation. Utah began providing a defined contribution option to new hires in 2011, and Colorado expanded a similar DC option in 2018. Florida made its DC option the primary retirement choice for most public employees and recently granted significant improvements to that plan to improve retirement security. 

The next frontier for public retirement plans will be optimized defined contribution plans, which employ modern strategies to significantly reduce the likelihood of retirees outliving their savings. All of these examples showcase a collective emphasis on shared goals—specifically, ensuring adequate retirement savings not only for career employees but also for the vast majority who will eventually find themselves in different jobs or locations. 

Politically motivated debates about the effectiveness of traditional pension plans usually overlook a retirement plan’s actual objectives. With greater employee mobility, offering a retirement plan that provides portability of benefits is necessary. Flexible plan designs tailored to today’s employment reality do exist and are constantly evolving to keep up with broader workforce trends, but these options are much more prevalent in the private sector than they are for government workers.

Stakeholders in public retirement systems should move to adopt effective retirement plans for new hires while maintaining their commitment to existing employees in current pension plans.

The post Why traditional government pension plans don’t work for today’s new employees  appeared first on Reason Foundation.

Source: https://reason.org/commentary/why-traditional-pension-plans-dont-work-for-todays-employees/