Tag Archives: reform

Pension Reform Should Not Focus On All-Or-None Solutions

Remember the good ole’ days when retirement planning for most Americans involved income being illustrated as a three-legged stool where the legs of the stool represented 1) income from a pension, 2) Social Security, and 3) personal savings? The thought was that as long as the stool has three legs it will be strong enough to support the person sitting on it. Take one of those legs away, and the stool becomes much less stable. Take two of the legs away and you end up on your back.

So why is it that every time I read about pension reform the proposed solution is always an all-or-none scenario where the pension will be shut down in favor of individual 401(k) accounts? This solution completely removes one leg of the stool (the pension) and reduces the retirement readiness for everyone affected. At LAGERS, we believe everyone who works hard and plays by the rules deserves a secure retirement and that this is best achieved by the three-legged stool approach.

When 401(k)s were first conceived in the late 1970’s, they were never intended to replace pensions, but to supplement the pension plan while allowing employees to defer taxable income. This was originally a great concept – one that furthered the notion of the three-legged stool. But over time, employers have eliminated their pensions and gone completely to the 401(k). The supplement has now become the main retirement income vehicle for many Americans. And it isn’t working. Even if their employer offers a 401(k), two-thirds of Americans aren’t using it to save for retirement.

One of the reasons Americans aren’t saving more is because investing as an individual is hard. Nearly seven of ten Americans cannot pass a basic financial literacy test. The average American worker is just not equipped to know how much to invest, what to invest in, when to re-allocate, and then how to turn their savings into a lifetime stream of income. Also, many Americans simply don’t have the means to go-it-alone in 401(k) accounts. The recommended retirement savings rate for an individual without a pension plan is north of 10% of income. For low-to-middle income workers, this is a daunting, if not impossible task. Pension funds, on the other hand, are invested by professionals and benefit from pooling so that one individual is not taking on all of the market risks.

Watch: Pension vs. 401(k), What’s the Difference?

One argument for moving away from pension plans in favor of 401(k)s is that the individual accounts cannot create unfunded liabilities. This couldn’t be further from the truth. Both pension plans and 401(k)s can create unfunded liabilities. An unfunded liability is established when liabilities exceed assets. In other words, the money you owe is more than the money you have on hand. The presence of an unfunded liability is not necessarily a problem so long as there is a steady, predictable, and disciplined approach to making the required contributions. Individual savers create unfunded liabilities when they fail to save enough for their retirement. When more and more individuals enter into retirement without adequate savings and huge personal unfunded liabilities their only option to sustain themselves in retirement will be to seek public assistance.

The bottom line is this: we need pensions and we need 401(k)s (and similar programs). We should not be seeking solutions that eliminate any one leg of the stool, but rather, to make those legs work together to provide a more stable base for all Americans.

 

Jeff Kempker
Manager of Member Services

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Pension Reform Jeopardy: “I’ll take The Real Truth for $1,000, Alex!”

the word "reform" in lead letters written. symbolic photo for quick correspondence

These days you can’t turn around without hearing the phrase ‘pension reform’ and the great horrors pension systems and retirees are unleashing on society.  Everyone has an opinion and some are quite rabid about it.  The soundbites, inflammatory and many times downright false statements would be laughable – if these were not real peoples’ lives we were talking about.  We hear time and again that ‘defined benefit plans don’t work’ and there must be massive pension reform to solve this catastrophic crisis, right?  Wrong.

So here’s the truth.  Pension systems, when designed properly (like LAGERS) are an effective strategic tool used by employers to make communities better, safer and more efficient.  Defined benefit plans are designed to attract skilled, quality workers and give them incentive to dedicate their service and skills to improve their communities.    Then after a career of work, when the employee can no longer function at maximum level, a pension provides a mechanism for exiting the workforce with dignity and security through modest, protected monthly benefits. This workforce movement also provides incentive for younger workers to follow that same path.  Defined benefit plans create loyalty and partnerships between employees, employers and communities.

Some of the pension reform discussion has focused on eliminating defined benefit pensions altogether and transitioning public workers into 401(k)-type defined contribution plans.  While it is always good to look into ways to be more efficient and improve the financial condition of pension systems, switching government workers from a defined benefit pension plan to a defined contribution plan will ultimately hurt the retirement security of workers and be more costly to governments.

In fact, a study from the National Institute on Retirement Security found that converting from defined benefit to defined contribution plans actually increased costs and pension under funding.  Case Studies of State Pension Plans that Switched to Defined Contribution Plans summarizes the impact of switching from a defined benefit pension to a defined contribution in three states – Alaska, Michigan, and West Virginia.

One state, West Virginia, who moved to a defined contribution plan in 1991 actually switched back to a defined benefit plan 14 years later.  After studying the costs of going back to a defined benefit plan in 2003, the state found that the normal cost (the cost of benefits accrued in a single year) for its defined benefit retirement system was nearly half of the required employer contribution to the defined contribution plan.  This is why the state decided in 2005 to put all new hires into a defined benefit plan.

Even more, in the last 5 years 70 employers have joined LAGERS and we found some interesting news:  two out of three employers were switching from some type of DC/investment type plan into the LAGERS defined benefit structure.  Why?  Because LAGERS works well, for everyone. 

And there’s more!  Do you want to know the ‘secret sauce’ to making a pension plan work?  Requiring contributions be made.  As simple as it sounds, that’s why LAGERS works so well.  As a system we are 670 employers strong, all of which make their required contributions each and every month to ensure the earned benefits are prefunded.  To date the system as a whole is 94.4% prefunded, even including the employers recently joining – who have not yet had a chance to fully fund all of their benefits.  Our system ensures benefits will be funded, and secure.

If you want to join the debate, I urge you to take a close look at the state of worker pensions and security – or insecurity – across the country, both public and private.  Everyone should have the chance to earn some type of modest, secure defined benefit that they know will be there when they can no longer work.

 

Robert Wilson, Asst. Executive Secretary

Robert Wilson, Asst. Executive Secretary

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