Will Switching Government Workers to Account-type Plans Save Taxpayers Money?

Source: Monique Morrissey, Economic Policy Institute, Briefing Paper #390, March 5, 2015

Although benefit cuts, increased employee contributions, and a rebound in stock prices have improved pension fund finances, severe underfunding remains a challenge in places where the problem predated the recession and was the result of lawmakers neglecting to make required contributions over many years.1 This is helping to sustain the idea that we can no longer afford to provide teachers, police, firefighters, and other civil servants with secure defined-benefit pensions.

Earlier would-be reformers pushed for 401(k)-style defined-contribution (DC) plans prevalent in the private sector. But disastrous results in West Virginia, Michigan, and Alaska have shifted attention to “hybrid” plans, such as cash balance plans, that combine elements of defined-benefit and defined-contribution systems. Advocates of these types of plans say they are a compromise between those who want to maintain traditional pension plans and those who push for a transition to a 401(k)-style system. However, DC and hybrid plans, which can collectively be referred to as account-type plans, fail on three important points:
· They do not help states save money. Traditional defined-benefit pensions are more efficient than DC plans and most hybrid plans due to economies of scale, risk pooling, and other factors. Moreover, changing plan type introduces transition costs. Thus, it is not surprising that states that switched to DC and hybrid plans did not save money except to the extent that they simply cut benefits or required workers to contribute more toward their retirement.
· They create more workforce management problems than they solve. For example, many cash balance plans provide the biggest benefits to job leavers, promoting high turnover in public-sector jobs, which require a high level of skill and experience.
· They increase retirement insecurity. Account-type plans introduced around the country threaten the retirement security of young and old alike. While a well-designed hybrid plan could theoretically help younger workers without undermining the retirement security of midcareer and older workers, none of the plans offered in the current political climate has done so.
Related:
Press release