Environmental, social, and governance issues are commonly packaged together in investment discussions through the ESG acronym, but a closer examination of these components raises questions about the value of grouping these things together.

It is evident that the concept of ESG investing owes its existence to politics by simply looking at its components. Why else would environmental, social, and governance criteria be lumped together other than for political positioning? Why not past, present, and future?  Or animal, vegetable, or mineral? 

Some idealists with a political agenda made the determination that these separate elements, ESG, were, in total, critical for long-term investing success, as well as other broader goals. They were also successful in positioning these three elements as a singular, necessary approach to investing success. ESG opponents then emerged, and the debate commenced. Through years of engagement, even opponents contributed to the idea that these three elements should be treated as one. Their position then became one where absolutely no credence could be given to any ESG investing criteria.

A prudent person, on the other hand, can see elements in standalone environmental, social, and governance issues that should be considered when public pension systems are making investment decisions. That same prudent person would also see that not every one of these issues should be applied to each and every investment decision. In fact, it is just as foolish to eliminate all such criteria from investing as it is foolish to include all such criteria. 

Fortunately, public pension fund trustees must follow prudent fiduciary standards, which set boundaries on how investment decisions are to be made. Given this, public pension fund trustees are afforded a perfect path to avoid the purely political argument that ESG investing has become. Fiduciary standards require that pension fund trustees make investment decisions based on providing the best possible financial outcomes consistent with the pension plan’s objectives for the plan’s participants and for the plan itself. 

All-in or all-out ESG investing is not sound, prudent fiduciary policy.  Therefore, public pension fund trustees should make investment decisions based on practical and sound financial criteria, not based on political ESG classifications that prioritize other factors above returns and volatility. The likely outcome of prudent decision-making is that some decisions will be made that align with the ESG approach, and others will not. All of these decisions, however, must be made for the good of the pension plan’s members and not to satisfy political agendas. 

The practical approach to responsible public pension system governance is there, fiduciaries just need to follow it.

The post Public pension fund trustees have a perfect path to avoid the politics of ESG investing appeared first on Reason Foundation.

Beyond the growing pressures of crippling unfunded liabilities, DB plans suffer from a fatal flaw – they are unable to meet the portability needs of today’s highly mobile workforce. Only about one-third of plan participants will ever receive a meaningful benefit from a public DB plan.  

Another significant shortcoming of DB retirement plans is a failure to address specific individual needs. In a traditional DB plan, every person with the same salary and length of service is eligible for the exact same annual benefit. But treating everyone the same ignores the reality that individuals are almost never average. Individuals have different needs based on many factors, such as health or other sources of income.   

A typical DC arrangement suffers many of the same shortcomings. Managing investment risk is often solely on the shoulders of participants. Default investments often use target date funds, so every person with the same birthdate has the same investment mix regardless of circumstances.   

Neither DB nor DC plans are able to meet the needs of broad swaths of individuals. Historically, cost restrictions have made it difficult to design a plan that recognizes individual needs while covering a wide range of participants. Fortunately, that is no longer the case. 

To address these traditional design shortcomings, and in partnership with the Pension Integrity Project at Reason Foundation, we applied decades of retirement plan-related experience to develop a new design approach: The Personalized Retirement Optimization Plan (PRO Plan). This new plan design uses a mix of tested and proven options, making it easy for policymakers to implement. Offering a wide range of individual flexibility in contributions and annuities, the Pro Plan can better fit the unique retirement needs of each individual, making the plan advantageous not only for employees but for employers looking to better serve and retain their workers. 

The PRO Plan starts with the endgame in mind: a lifetime of inflation-protected replacement income. With immediate or very short vesting periods, the plan allows all participants (not just a few) to earn meaningful benefits. It also allows individuals to tailor and structure funding of the target benefit and benefit distribution strategy by first using independent financial advisors and/or advice tools to determine the appropriate investment strategy.  

All other assets available to the individual are considered, including other retirement plans, spousal assets, inheritance, and others. While participant input is critical for success, it is not overly burdensome and only needs periodic updating. This input enables the creation of an appropriately risk-managed and liability-driven portfolio that is adjusted as appropriate throughout the working career. Utilizing a combination of plan-provided annuities and other distribution methods, a default income plan is created that is specifically tailored to the individual.   

Our analysis comparing this new design to existing options finds that the PRO Plan addresses many of the common shortcomings and enables each participant to address their specific retirement needs. Using existing market-based products and modern financial technology, the PRO Plan enables government employers to provide lifetime-guaranteed benefits to their employees, and in a way that is cost-effective. Our research indicates that our new plan design could meet the needs of retirees at 28 to 38 percent lower cost than it would be for an individual covering lifetime benefits on their own. 

Applying some of the best features found in DB and DC plans, along with modern financial technology, the PRO Plan can meet both employer and individual employee needs for a more effective retirement plan. Rather than attempting to fix current plans, the PRO Plan is a design that should be considered throughout the public sector as a plan that policymakers can fully implement today. 

The post A better public sector retirement plan for the modern workforce  appeared first on Reason Foundation.

With most private firms shifting workers to 401(k)-style defined contribution (DC) retirement plans since the 1980s, the state and local government market is effectively the last bastion of traditional defined benefit (DB) pension plans. However, even among governments, the ubiquity of traditional pension plans has been slipping. And much of the movement away from traditional DB plan designs has been caused by accumulated unfunded liabilities that are fiscally burdening both the pension plan and jurisdictions’ budgets.

Public pension reform has been seen as a binary choice: the traditional DB or a 401(k)-style DC plan, with the latter option frequently presented as a standalone retirement option. In practice, a traditional 401(k) on its own will rarely comprise a core, or primary, retirement plan. This is because this type of plan was designed, and functions best, as a supplemental, employer-sponsored, tax-deferred savings plan.

This study presents a new retirement plan design, the Personal Retirement Optimization— or PRO Plan, which is built on a DC foundation but designed to operate more like a traditional pension. The DC foundation for the PRO Plan was chosen because it allows more public employees to accrue valuable retirement benefits regardless of length of service compared to defined benefit approaches. The design uses cutting-edge financial technologies to focus on providing plan participants with a predictable and customizable retirement income. It uses a liability-driven contribution (LDC) approach, tailored to individual situations and needs, for determining necessary contribution levels. Primarily concerned with risk-managed income adequacy in retirement, it addresses wealth accumulation only as a secondary objective. The PRO Plan provides participants the flexibility to choose an asset distribution methodology but uses several types of currently available annuities as a default method. The annuity default, combined with proper financial education and advice, tailor the PRO Plan income to an individual’s unique situation.

This study illustrates the effectiveness of the PRO Plan design in meeting individual retirement needs while effectively managing employer workplace expectations. To do so, the study elaborates on various scenarios that are relevant for the public sector. This analysis compares the relative funding requirements for three separate longevity scenarios:

• Scenario 1: Do-It-Yourself (DIY) – the individual self-insures their personal longevity for the entire period until age 95.
• Scenario 2: QLAC (deferred annuity) – the individual purchases an IRS Qualified Longevity Annuity Contract to address longevity risk from 85 to 95.
• Scenario 3: 100% Immediate Annuity – the individual purchases an immediate life annuity at retirement age 67 for the entire stream of payments.

Each scenario’s funding requirement is based on an actuarial analysis of net present value of a stream of inflation-adjusted payments starting at age 67 until age 95 (or death). We found that a DIY scenario was the costliest PRO Plan alternative. Our analysis shows that a typical mid-level earner at age 67 would require $1,050,000 under the DIY scenario. The QLAC scenario requires 28% less funding, or only $760,000. The 100% Immediate Annuity scenario requires 38% less funding than the DIY scenario, or $652,000, to achieve the same retirement income.

To show how the PRO Plan would work when the target benefit accumulation is greater or lesser than needed, we analyzed both a shortfall and excess $100,000 in plan accumulations at age 50. These scenarios showed that PRO Plans would better protect individuals by positioning them to adjust savings rates up or down as needed. Similar to the baseline scenarios, the QLAC and 100% Immediate Annuity options require lower additional contributions to allow participants in shortfall situations to reach the target retirement benefits.

This study serves as a hands-on tool for public fund managers willing to implement the PRO Plan option. In addition to providing the reader with various scenarios, it details all the plan features necessary for its successful implementation. The PRO Plan is an innovative way of incorporating the benefits of 401(k)-style solutions into modern-day public sector retirement plans that give their workers flexibility and predictability of their benefits.

A state or local government employer seeking to implement a new retirement plan or redesign their existing retirement plan should always begin by clearly identifying sound retirement benefit design principles and using those principles to determine and articulate the objectives of that plan. The principles and resulting design should include as the primary objective providing a share of lifetime income, attributable to the employee’s tenure, enabling the employee to maintain their standard of living in retirement. The design of the plan should provide the flexibility to meet the needs of employees in varying circumstances. Of course, other workplace objectives of the employer and financial realities for plan sponsors should also be considered.

Standard DB and 401(k)-type DC plans are often compared with little regard to the simple question of what design elements provide the greatest utility to the greatest number of employees while still serving the employer’s workforce management objectives. Many arguments have been advanced on all sides of the issue, some valid, others not so much. The real answer to the question of what type of plan most aids recruiting and retention is a plan that best meets the varying needs of most employees.

This analysis concludes that providing retirement benefits and savings solutions that adjust to meet the different and changing needs of employees is what will more likely aid employers in attracting and retaining quality employees.

The PRO Plan design is specifically crafted to be adaptable to the needs of the broadest cross-section of employees possible. The focus of the plan is on providing employees with the target retirement income replacement ratio determined by the employer. Income replacement is the primary objective, with wealth accumulation a secondary consideration. Importantly, the plan, based on employer-specific criteria, can have a longevity annuity default that can be opted out of by employees meeting certain specific criteria. The mandatory contribution rates for both employer and employee, as defined by the employer, combined with the investment design and distribution controls, are all designed to minimize risks for the employee while meeting employer workplace objectives.

The Personal Retirement Optimization Plan: An Optimized Design For State And Local Government Employees

Frequently asked questions about the Personal Optimization Retirement Plan

Webinar: The Personal Retirement Optimization Plan

The post Designing an optimized retirement plan for today’s state and local government employees appeared first on Reason Foundation.

Built on a defined contribution foundation, the Personal Retirement Optimization Plan described fully in this new study improves on traditional designs with clear and measurable objectives on maximizing benefits for a wide range of individual situations, flexibility in both investment and benefit distribution options, and an emphasis on guaranteed lifetime income through annuities.

In short, the PRO Plan blends the risk management benefits to employers associated with DC plans with the lifetime income protections public workers value in pension plans. Executed correctly, the PRO Plan could provide a more secure DC benefit at a lower cost to governments and taxpayers.

Full Study: Designing an optimized retirement plan for today’s state and local government employees

Webinar: The Personal Retirement Optimization Plan

The post Frequently asked questions about the Personal Retirement Optimization Plan appeared first on Reason Foundation.

The PRO Plan is built on a defined contribution foundation but is designed to operate more like a traditional pension plan. The DC foundation for the PRO Plan was chosen because it allows more public employees to accrue valuable retirement benefits regardless of the length of service compared to defined benefit approaches. 

This discussion and study serves as a hands-on tool for public fund managers willing to implement the PRO Plan option. The Personal Retirement Optimization Plan is a way of incorporating the benefits of 401(k)-style solutions into modern-day public sector retirement plans that give their workers flexibility and predictability of their benefits.

Full Study: The Personal Retirement Optimization Plan: An optimized design for state and local government employees

Frequently asked questions about the Personal Optimization Retirement Plan

The post Webinar: The Personal Retirement Optimization Plan appeared first on Reason Foundation.

These trends are becoming more prevalent, both in the choices individuals make with their own investments and the policies implemented by institutional investors and public pension systems.

Since ESG debates and activist investing look to be a significant subject of contention for the foreseeable future, it is essential to draw clear lines of when it is and is not appropriate to implement investment strategies that overstep the usual purpose of meeting specific financial objectives, especially in the case of retirement savings.

It is entirely appropriate for individuals to make whatever investment decisions they like with their assets. Giving individuals a choice in where to place their assets is healthy and consistent with long-standing American investment tradition. Look to the long history of specialized or sector funds for examples. Of paramount importance with these investments is that their objectives and methods are made clear to potential investors through the prospectus and other communications materials. Individuals having the ability to invest with their conscience in a way consistent with their beliefs and objectives is laudable and is consistent with a free society.

Recently, however, activist investing has been pushing in a more dangerous direction. There are serious concerns when activism is involved with pooled retirement investments, like public pension systems. Public pension plans should not engage in political activism. Unfortunately, lawmakers and officials on all extremes of the political landscape are increasingly attempting to dictate how investment funds maintained for various governmental functions must be invested.  The trends, both promoting ESG and anti-ESG, are being directed at state and local government-run pension funds for public employees.

Pension fund investment managers have a fiduciary responsibility to manage their funds exclusively to best meet the financial needs of plan participants. In the case of retirement plans, those needs are for long-term income stability and sustainability within closely managed risk guardrails. It is also clear that activist investment mandates are inconsistent with these fiduciary responsibilities and retirement plan objectives.

To be clear, this is happening on both the left and right across the country’s political spectrum. For example, those that want to exclude oil company investments in public pension funds as well as those that want to mandate the inclusion of oil company investments in public funds. Neither of these positions is directed at improving public employee retirement incomes.

The demand for investments that match certain political or policy beliefs and the increasing pressure on state and local government-run pension systems to ignore their fiduciary responsibilities in favor of politically-motivated investing present more reasons for governments to examine alternative retirement plan designs immediately. It has become more widely understood that the traditional public sector defined benefit (DB) pension plan no longer meets the needs of many of today’s public employees and other impacted groups. Employees are increasingly mobile in their careers, and traditional defined benefit pension plans cannot effectively meet workers’ portability needs.

Traditional DB plans also fail to meet many employers’ needs, impacting their ability to recruit and retain qualified employees. Additionally, in many cases, traditional DB plans’ funding status continues to deteriorate, putting increasing pressure on taxpayers and on state and local government budgets.

From public pension debt to failing to serve today’s workers to misguided politically-motivated investment pressures, it is clear that the public retirement space is due for some recalibration.

Retirement plan designs that are built on a defined contribution (DC) foundation and have objectives focused on lifetime income and risk management can be the leading-edge answer to many of today’s public pension dilemmas.  Sophisticated design structures incorporating defined benefit-like features into a defined contribution construct, uncomplicated from an employee perspective, are available and in use today.

With these plans, sponsors can make available many employee-selected investment options that do not force the employee into heavy-handed, politically-motivated investments or ones they oppose morally. With the help of an independent financial advisor, if desired, individual employees can build a portfolio that best meets their personal goals and objectives.

It should seem obvious that retirement plans must focus on meeting the objectives of several interested parties, most notably the public employee participants. Attempting to impose politically-motivated investment controls of any kind on public pension plans violates core fiduciary standards and is a gross over-reach by governments. Instead, lawmakers and workers should seek to modernize public retirement plan designs in ways that give individuals the flexibility to vote with their feet, have plan portability when they change jobs, and invest as they see fit.

The post Politics and ESG endanger public pension plans and workers’ retirements appeared first on Reason Foundation.

This is a review of Alaska’s defined contribution retirement plan (DCR), also referred to as Tier 4, and the Alaska Supplemental Annuity Plan (SBS-AP). The comments relate to the efficacy of these plans for employees’ retirement, with an emphasis on public safety employees.

In this analysis, we’ve used the leading best practices from our policy brief, Defined Contribution Plans: Best Practices in Design and Utilization, outlining the gold standard as a measure of the two plans. Alaska’s retirement plans meet best practices in some areas but need some improvement in other areas, as described below.

Summary of Alaska’s Pension Plans

• Alaska Defined Contribution Retirement Plan (DCR): The DCR is a retirement plan within the Public Employees’ Retirement System (PERS). It is a defined contribution, multiple-employer public employee retirement plan established by Alaska to provide pension and post-employment health care benefits for eligible state and local government employees hired after 2006.

As of June 30, 2020, 152 employers were participating in PERS-DCR. According to the state’s annual report for the fiscal year ending in June 2020, there were 23,478 plan members, of which 21,243 were general employees and 2,235 were peace officers and firefighters.

There are three benefit components: 

• DCR Plan—a 401(a) plan
  • The PERS Retiree Medical Plan (RMP), which provides retiree health insurance (after 25 years of service and retirement directly from active employment) and a Healthcare Reimbursement Arrangement Plan (HRA)
  • The Occupational Death and Disability (OD&D) Plan, which pays 50% of covered compensation (nontaxable)
• Supplemental Annuity Plan: This plan, SBS-AP, is a defined contribution plan that was created under Alaska statutes effective January 1, 1980, to provide benefits in lieu of those provided by the federal Social Security system. All state employees who would have participated in Social Security if Alaska had not withdrawn from it now participate in SBS-AP instead.  Other Alaska employers whose employees participate in PERS and meet other requirements are eligible to have their employees participate in SBS as provided by Alaska statute. There were 21 participating employers in SBS-AP, including the state, and 49,552 participants in the plan as of June 30, 2021.

Note: Teachers covered under the Teachers Retirement System (TRS) are not eligible to participate in the SBS-AP. Not all public safety employees of political subdivisions participate in the SBS-AP, only those of the state and the few political subdivisions that have adopted it. According to the Alaska Division of Retirement and Benefits, just 25 of 199 PERS employers offer access to the SBS-AP.

Definition of Plan Objectives

Employee communication materials for the plan continually refer to meeting employee objectives, but a well-defined pension plan objective is not clearly stated in authorizing statutes or the primary informational handbook. The defined contribution plan handbook says: “Your retirement plan is designed to keep pace with your career; on your very first day of work you are in control. Your defined contribution retirement account is participant-directed, requiring your attention and understanding as you choose investment funds that fit your needs.”

While this is a welcome approach, there ideally would be a more explicit statement of what the pension plan is working to achieve on behalf of participants. The SBS-AP handbook does not address the plan’s purpose other than noting it exists instead of Social Security.

Communication and Education

The DCR plan and SBS-AP make various communication and education services available to participants. Services range from group seminars and meetings to individualized advice and guidance offerings. Individual participants should be cautious about using higher-priced managed account services that may not be necessary.

Automatic Enrollment

New employees are automatically enrolled in the plan, and contributions are directed into an age-appropriate target date fund until the employee makes a positive election. This approach satisfies the auto-enroll best practice.

Contribution Adequacy

Given that state and most political subdivision public employees in Alaska do not participate in Social Security, total contribution rates (employer plus employee) of 13% for PERS employees and 15% for TRS employees are inadequate on their own to adequately fund a retirement benefit that will enable a retiree to maintain their standard of living following a career of employment.

Fortunately for PERS employees, when SBS-AP benefits are considered, the total employer and employee contribution rates increase by 12.26% for a total of 25.26% for PERS employees. Additionally, 3% of pay is contributed to the HRA benefit.

TRS employees, however, do not participate in the SBS-AP, leaving their 15% DCR contribution substantially below the target contribution range of 18-25% for those not covered by Social Security.

There is also a potential major shortcoming in the Alaska DCR for public safety employee participants. Public safety employees generally retire at an earlier age than general classification employees because of the requirements of their jobs. Funding an earlier retirement date requires a higher contribution rate. It is generally accepted that without Social Security and earlier retirement ages, the total contribution rate for police and fire employees should be a minimum of 30%. With public safety workers participating in PERS and not participating in Social Security, the combined 25.26% contribution rate is well below the suggested 30% contribution.

There is also a chance that some public safety employers are not offering the SBS-AP benefit, which would put those police and firefighters woefully below suggested levels in contributions.

Retirement-Specific Portfolio Design

The investment menu for Alaska’s DCR plan generally meets best practices. Single-choice target date options are available, and for individual participants desiring a more customized portfolio, the plan offers a range of advice and guidance services. The primary menu includes 16 options, including mutual funds and Alaska-managed balanced funds. In plan annuity, accumulation period options are not offered.

Portable Benefits

Accumulations attributable to employee contributions are, of course, immediately vested.  Accumulations attributable to employer contributions are not fully vested for five years. Vesting is on a pro-rated scale beginning with 25% vested after two years of service and growing to 100% after five years. Full and immediate vesting of these employer contributions would be preferred to meet the needs of today’s more mobile workforce. A five-year vesting timeline is especially long for a defined contribution retirement plan.

Distribution Options

The plan makes various distribution options available ranging from leaving the assets in the plan to various fixed-period and lifetime annuities. The offerings cover best practices, but other than distributions required by regulations, there are no requirements for a lifetime income.

Disability Coverage

Alaska’s DCR plan presents itself as a hybrid plan because of the non-retirement benefits it provides to public employee participants. These benefits include disability and retiree health care. These benefits appear to be generous and satisfy best practices.

Sept. 14, 2022—Editor’s note: This piece has been corrected to reflect the fact that TRS members are not eligible to participate in the SBS-AP Social Security replacement plan.

For more information and an in-depth scorecard, please see:

Does the Alaska Public Employees’ Retirement System Meet Defined Contribution Plan Design Gold Standards?

The post How Alaska’s defined contribution plan and supplemental annuity plan compare to the gold standard appeared first on Reason Foundation.

The MissionSquare Research Institute, along with the International Public Management Association for Human Resources (IPMA-HR) and the National Association of State Personnel Executives (NASPE), conducts an annual survey of human resource professionals in state and local governments aimed at tracking challenges facing public employers in recruiting and retaining employees. The survey, which had 319 state and local government respondents, indicates that 55% of respondents hired more full-time employees in 2022 than in 2021 with another 32% reporting no change in hiring from year over year. Only 14% of respondents reported hiring fewer full-time employees in 2022 than in 2021.

While the hiring of full-time employees significantly increased year-over-year, 69% of respondents also reported voluntary (non-retirement) separations of service (i.e., people quitting their jobs) increased in 2022. Another 26% had resignations in 2022 that were consistent with 2021—only 5% saw a reduction of service separations. With high levels of hiring, it becomes clear that recruiting and retention should not be combined when evaluating needs. The factors that help attract employees to a particular employer are clearly not the same factors that keep them employed there. Not surprisingly, non-competitive compensation was the number one reason cited for employees leaving their jobs.   

The survey further reports that 77% of responding organizations made no changes to their retirement plans in the current year for either current employees or new hires. For those that did make changes, only 1% replaced a traditional defined benefit pension plan (DB) plan with a hybrid plan for existing employees, 1% replaced a DB with a hybrid plan for new employees, and another 1% implemented a choice between DB and defined contribution (DC) for new employees. 

A number of conclusions regarding the retirement plan’s impact on recruiting and retention can be drawn from the MissionSquare survey results:  

1. Recruiting and retention should not be looked at as a singular issue. While public employers have seen steady success in hiring, retention has suffered greatly in recent years in the public market. 

2. The survey does not make the case that an employer’s retirement plan, whatever the design, has a substantial impact on recruiting or retention at all. In fact, the survey shows employers are more focused on employee morale, development, and engagement to enhance retention, along with salary increases. The survey does not suggest that there is a widespread recruiting issue although some positions, including nurses, engineers, and police officers, are more difficult to hire than others. 

3. Plan sponsors should avoid treating retirement plan design only as a tool for retaining employees. Rather, they should focus on a retirement plan design that realistically meets the needs of a modern workforce. The retirement plan should focus on providing lifetime income in retirement commensurate with the part of a career that an employee spends with a particular employer. The plan should recognize the realities of mobile modern employees and should not penalize employees that do not spend a full career with one employer. 

4. The survey illustrates that employers are focused on employee wellness as a means to improve retention. It follows that keeping employees happy should also be the focus of the retirement plan. Retention is best addressed by having a retirement plan that addresses the realities of the workforce today, as noted above.  

In the state and local government marketplace, it is imperative that employers focus on retirement plan designs that recognize and meet the needs of the modern workforce. Pension designs from decades ago that seek to lock employees into jobs simply do not work today.   

Alaska narrowly avoided a major setback this past legislative session when legislation to eliminate their forward-looking defined contribution plan in favor of a poorly designed defined benefit plan fell short. While the thinking behind the legislation was that a traditional pension would help recruit employees, this polling suggests the data do not support that position. In fact, it is likely that a plan that clearly does not meet the career patterns of modern employees will not help with recruiting or retention of qualified employees in a competitive labor market.  

Rather than trying to design retirement plans with recruiting and retention goals in mind, public employers should adopt plans that best meet the realistic career patterns of employees and prospective employees. This will not only keep employees satisfied but will also enhance the employer’s ability to meet broader workplace objectives, including recruiting and retention. As the MissionSquare survey indicates, state and local government employers are focused on improving the employee experience as they work to retain employees they have recruited. A retirement plan that meets employee needs keeps them happy and ties into other employer efforts toward employee satisfaction.  

The post Retirement plans’ impact on recruiting and retention in the public market appeared first on Reason Foundation.

Which plan type does a better job of actually delivering benefits to the most people?  

It is important to understand the often-overlooked concept of benefit efficiency in concrete conditions. To demonstrate, a hypothetical retirement plan called PERS (Public Employee Retirement System) can serve as a stand-in. This hypothetical pension system uses common characteristics among public retirement plans that offer both DC and DB options. A full list of parameters used for this modeling is provided at the end of this piece. 

Using these parameters and other turnover and mortality data, this piece will examine how a DB plan compares to a DC plan for a cohort of 1,000 employees by comparing their accumulated benefits over a potential lifetime (based on mortality rates). This analysis demonstrates that the DB plan does become optimal when compared to a DC plan for an individual around age 55-60 depending on the entry age. However, for a group of 1,000 employees and for certain entry ages like 22, the DB plan as a whole is never more valuable than the DC plan as a whole. 

For this hypothetical plan, only 33% of workers starting at age 22 remain in their jobs after five years, which is in line with expected retention rates for most public pension plans. For later entry ages, retention beyond the first five years goes as high as 50%. At the 30-years-of-service mark, only about 8%-to-12% of employees remain in their jobs, depending on the entry age. 

DB vs DC analysis for a group of employees 

To include a valuable comparison of how portable DB benefits are compared to DC benefits, the comparison of accumulated benefits will only be made for employees who leave the system. This analysis assumes that a person in a DB plan will try to attain their maximum possible benefit, meaning that if a PERS employee separates (in other words, take another job) at age 35, this comparison would be for their accumulated DC balance to the maximum possible DB benefits they could collect by waiting until the pension systems retirement eligibility. 

The first scenario looks at the cumulative benefits distributed between DC versus DB plans for a standard entry age of 22. Figure 1 shows the cumulative benefits of a DC versus DB plan for every new employee that leaves the system. The first thing that stands out is the stark increase in balances at age 60 for both the DC and DB plans.  

This increase is for two reasons: a spike in retirement rates and a spike in individual DB benefits. For retirement rates, about 940 people leave the system by age 60 and within just six years only two-thirds of them remain. Therefore, even though the individual DC balances grow steadily over time, the cumulative DC balances also spike because this analysis looks at cumulative balances for those who leave the system.  

As for the spike in individual DB benefits, it is a little more nuanced. The DB benefit becomes better than the DC benefit for an individual around age 56 when the person has worked for 34 years and is eligible for full retirement under the “Rule of 90” (see appendix). This relative value of a DB over a DC plan increases and peaks at age 60 where the maximum possible DB benefit at age 60 is 35% more valuable than the DC plan. This combined with increased retirement rates leads to a massive spike in cumulative DB balances around age 60.  

Despite the rise, the DB never crosses the DC plan in cumulative terms for this entry age. That is because the DB plan eventually becomes worse than the DC plan if the person waits too long to retire, specifically at a cutoff point around 70. While the annual benefits will increase for those working longer, a person may not live long enough to reap the full benefits, and thus it is no longer advantageous.  

Figure 1: Cumulative Benefits Distributed (Entry Age 22) 

This trend differs slightly but is still similar to other entry ages. In Figure 2, the ratio (vested DB benefits to vested DC benefits) is used to make a similar comparison of cumulative benefits for an aging workforce using different ages of entry. 

Figure 2: Ratio of Cumulative Benefits (DB/DC) for different entry ages 

At the entry age of 52, the defined benefit plan quickly becomes a better option when compared to the defined contribution plan due to early retirement eligibility. Of course, entering the workforce at 52 is not a typical scenario for most people and neither is staying at a job long enough to enjoy the comparative advantage of a defined benefit plan, as this analysis shows based on the retention rates.  

Conclusion 

The claim that a defined benefit plan is more efficient than a defined contribution plan, purely on a basis of cost, overlooks a larger and more meaningful perspective regarding benefit distribution. Most members of a DB plan do not stay at their jobs long enough to enjoy this “efficiency.”

Using the hypothetical PERS plan, fewer than 12% of employees make it to full retirement across all entry ages, yet the advantages of the DB retirement benefits seem to be tailored to this select group only. The vast majority of workers are better off with a defined contribution plan because the benefits they earn are not frozen when they leave for other employment. 

Additional notes on this analysis

Key Parameters 

1. Assumed Inflation – 2.25% 

2. Salary Growth Rate – 3.50% 

3. Vesting Period – 5 years 

4. Final Average Salary – 5 years 

5. Interest Credit – 6.5% 

6. Benefit Multiplier – 2.00% 

7. COLA – 0% 

8. Assumed Rate of Return – 7% for DB Plan, 6% for DC Plan 

9. Employee Contribution rate – 7% for DC and DB Plan 

10. Employer Contribution rate – 7% for DC and DB Plan 

Retirement Conditions 

1. Regular Retirement 

• Age 65 with 5 years of service 
• Age + years of service >= 90. Known as the rule of 90 

2. Early Retirement – Age 60 with 5 years of service 

This analysis assumes a 6% return for the defined contribution plan and a 7% return for the defined benefit plan. This is based on the NIRS assumption that the DB plan is managed by sophisticated fund managers and can therefore generate higher returns. This point was rebutted in the previous piece based on returns generated by pension funds vis-à-vis index funds to highlight the value of fund managers. This analysis focuses on benefit distribution, so the assumption of a higher DB return is used. 

The post Examining the populations best served by defined benefit and defined contribution plans appeared first on Reason Foundation.

State executives and lawmakers from both major political parties have recently threatened to use public retirement plan assets to address political grievances or push political agendas. Issues ranging from guns to oil and climate change to social media are all being suggested as political targets that should dictate investment strategies for public pension funds. When making arguments for their activist agendas, proponents of these various positions rarely mention how investment restrictions or demands will aid in the basic retirement plan objective of supporting public employees in their retirement years.  

To be clear, public retirement plan assets should never be utilized for political purposes.

Trustees of these public pension plans, and others of influence, are under a clear fiduciary obligation to make decisions with the sole purpose of best meeting the pension plans’ objectives for the benefit of that plan’s participants. There is no ambiguity about this: Activist political agendas have no place in public pensions. To be effective in meeting their objectives, public pension systems must be completely apolitical in their decision-making and in their operations. They cannot be beholden to shifting political winds.   

While this idea seems straightforward, the thought of using these massive investment portfolios to leverage certain political agendas is often too enticing for some politicians to pass up. It is incumbent upon governors, other key stakeholders, and legislative representatives in all states to step up and acknowledge that public retirement assets are out-of-bounds for activist maneuvering. This is critical regardless of where these figures fall on the political spectrum. It is equally important for retirement system trustees and leaders, as well as state treasurers, to stand firm as plan fiduciaries and vigorously oppose any attempts to use plan assets in a way that is not solely directed at benefitting the plan’s participants. 

Another area that has also needed a dose of reality is the actual design of public pension plans themselves. Thinking back to the basic tenet of serving employees noted earlier, how can it be that a pension plan design that ultimately benefits less than one-third of plan participants is meeting basic plan objectives? Yet, this is what the dominant current design in state and local retirement systems does. The long-standing traditional defined benefit (DB) pension design used by states and municipalities simply does not meet the needs of the majority of today’s modern mobile workforce. But, this defined benefit design is still defended rigorously by employee unions and many politicians.   

One argument continuously pursued by proponents of these public pension plans is that they supposedly aid in recruiting and retaining employees into governmental service. Yet, data show large numbers of public employees leave jobs without vesting or benefitting from these pension plans. For example, “only 2.5% of new hires joining LASERS [Louisiana State Employees’ Retirement System] at age 35 will stay in the system long enough to accrue a full retirement benefit. Seventy percent of LASERS members leave with only their employee contributions to return to them (without interest).”

All kinds of arguments can be made about the realities of recruitment and retention, but the simple fact is this: the kind of plan that aids in recruiting and retention is the plan that benefits the greatest number of employees. Cutting two-thirds or more of participants out of optimized benefits because of a pension plan’s inability to meet the portability needs of individuals cannot, obviously, attract today’s employees.

Plan designs exist that are proven to meet the needs of a greater number of employees while not creating unfunded liabilities for governments and taxpayers. More pension plan designs are being developed that take employee outcomes to an even greater level while managing risks for both governments and employees. These designs should be further examined to better meet basic plan objectives for all impacted parties. 

Politically-motivated activist investing and ineffective pension plan designs are just two areas of state and local retirement plans causing significant problems. Applying a simple dose of reality to these common issues would be a meaningful way to improve outcomes and better meet the basic objectives of retirement plans.

A simple litmus test should be applied when making decisions about any aspect of a retirement plan: Does this aid in achieving the plan’s objectives? 

The post Public retirement plan assets should never be utilized for political purposes appeared first on Reason Foundation.

It is generally recognized that a defined contribution structured retirement plan needs a contribution rate of between 12% and 15% of a worker’s salary (where employees participate in Social Security) to produce an income that is likely to maintain the employee’s standard of living once they are in retirement. For teachers and most other non-safety public workers in Florida, the contribution rate in the Florida Retirement System’s Investment Plan has been 3% by the employees and 3.3% by the employer, for a total of 6.3%. Unfortunately, this is effectively half of the total contribution necessary to effectively fund an appropriate retirement income. 

In House Bill 5007, the Florida legislature increased the state’s contribution to the FRS IP by 3% to a total employer contribution of 6.3%. This brings the contribution rate of government employers, i.e. taxpayers, to 6.3% and the total contribution rate up to 9.3%, certainly a substantial improvement. The increase is expected to cost $249 million next year. Ideally, workers would’ve also upped their contributions to FRIS IP but the state legislature is to be applauded for recognizing this shortcoming and for acting to improve lifetime financial security for state employees. This change may also aid in recruiting and retaining quality employees into state service as taxpayers put more money toward workers’ retirements and the plan better meets employees’ long-term needs. 

The FRS IP has been a plan that effectively meets most other best practices for defined contribution (DC) plan design. It provides a robust communication and education package for employees and has an appropriate investment menu that includes target-date funds for workers who may be less financially active or sophisticated.  There is also a broad selection of distribution options for employees to choose from, including lifetime income options. With all these positive design elements, the insufficient contribution rate has kept the plan from being a truly effective retirement vehicle. While the government’s 3% contribution increase goes a long way toward making the plan more effective, the total contribution rate remains insufficient. 

The Florida Retirement System Investment Plan should now examine how it can increase the required employee contribution by 3% to 6%, so the total contribution rate would rise to 12.3%. Legislative action will likely be needed, but increasing the employee contributions would create no additional cost to the state’s taxpayers. This increased contribution from workers would bring the FRS IP contribution total from 9.3% to 12.3%, a rate just above recognized standards so that workers could then expect to have the appropriate amount of money set aside for retirement.  

An employee contribution rate of 6% is quite comparable to other states with defined contribution retirement plans and could be an appropriate reciprocal response considering not only the state’s increase in its contribution but also the recent 5.4% across the board increase in salaries for all state employees, with some workers also getting additional raises. If workers express concerns about increasing their contribution rate all at once, state policymakers could examine the possibility of implementing the 3% contribution increase gradually over several years. Again, this would likely need to be spelled out legislatively. 

The momentum initiated by the important and laudable state action to increase the government’s contribution rate to the FRS IP should not be lost. But to be a truly effective retirement plan for state employees, and best aid employer workplace objectives, including recruitment and retention of employees, the total contribution rate still needs to rise into the accepted range of 12% to 15%.  

With the passage of House Bill 5007, the Florida Retirement System’s Investment Plan is much closer to being a model of effective public retirement plan design. Florida policymakers should now seize the opportunity to take the necessary step—increasing employee contributions to 6%, thereby having a total contribution rate into the plan of over 12%, putting the contribution rate in line with best practices.  

The post Florida improves FRS Investment Plan, but more needs to be done appeared first on Reason Foundation.

The reality of what kind of retirement plan could best aid public sector employers in recruiting desirable employees comes down to an examination of the following questions:

• Does the worker foresee him or herself changing jobs and employers several times during their working career, or do they expect to stay with one employer for 30 or more years? 
• If the worker does change employers during their working career, does he or she want to be able to take all of their accumulated retirement assets with them and continue to control them? Or does the worker want to rely on a future retirement benefit that is based on their age and years of service when they left the employer (if they were vested in the retirement plan at all)?
• Is a lifetime income benefit how the worker want to receive retirement income, or do they want the flexibility to receive a lifetime income or utilize other distribution methods tailored to their retirement needs?

Many state and local government employers have been convinced that only a traditional defined-benefit pension plan helps the recruitment of workers. While this may have been true for many public sector jobs a generation or more ago when staying in one job or with one employer for an entire career was far more common, it certainly is not the case today. The vast majority of today’s public sector employees, like their private sector counterparts, will change jobs and employers multiple times in their careers. This is the simple reality of the modern workforce.

Thus, a retirement plan that does not recognize the reality of employee mobility is not maximizing its potential in recruiting workers. If public sector employers continue to just repeat the mantra that a traditional pension is the only type of plan that helps to recruit workers, then they are likely hindering their efforts to recruit by not understanding the employment marketplace and why workers would appreciate the portability of some retirement plans.

A long-standing case in point in recognizing the need for mobility is the retirement plan that was developed for higher education (both public and private) more than a century ago. The traditional pension, with future benefits based on past salary and years of service, only rewarded employees who stayed at one university for a long time, given the back-loading of benefits. But a key ingredient in maintaining excellence in higher education was the mobility of faculty. Good professors were, and still are, encouraged to move to different academic environments several times during their teaching careers.

So to help facilitate this academic mobility and aid educational institutions in the recruitment of their desired professors from a nationwide pool, colleges and universities designed retirement plans to specifically address the need for portability. These retirement plans designed to embrace the mobility of professors have been adopted, over time, by almost all public and private higher education institutions in the country.

The plans were defined-contribution in nature but were also focused on lifetime retirement income. This is a significant differentiator from the typical 401(k)-style plan that defined contribution critics are wont to point to. These higher education plans were designed and administered as retirement plans, not supplemental savings plans. While not perfect, the plans in this nationwide system have performed exceptionally well over the more than a century of their existence. With all the discussions about the inadequacy of retirement benefits across jobs and industries, do you ever hear about college and university professors suffering from inadequate retirement benefits? Perhaps this is the best example of a retirement plan understanding the characteristics of the workers it was designed to serve.

A clear reality of the 21^st century is that employees across the spectrum are mobile in their careers. While employment tenure in the private sector is even shorter than in the public sector, the difference is irrelevant as far as retirement plan design goes. Recognizing reality is an important step in retirement plan design.

If a retirement plan is going to aid in the recruitment of quality employees, it must, like it does in higher education, recognize the realities of the workforce being recruited and appeal to those workers. Career mobility is a clear characteristic of the modern workforce and a retirement plan that recognizes this mobility and provides benefit portability is essential in aiding recruiting efforts. The traditional public sector pension plan does not recognize this mobility and, thus, is a weak aid in recruiting.

A defined-contribution structured retirement plan that recognizes employee mobility, is structured to focus on income adequacy in retirement, and can be tailored to individual situations, is the type of plan that public sector employers should strive for, either as a primary retirement plan or a valuable option among a menu of other types of plans. This proven plan design better meets the needs of the modern workforce and could serve as a recruitment tool for the majority of modern employees.  

The post The role of retirement plan design in recruiting workers to the public sector appeared first on Reason Foundation.

In the Summary Plan Description for the Florida Retirement System’s (FRS) defined contribution (DC) Investment Plan, it is stated that:

Financial security when you retire is an important goal, and one that the FRS can help you achieve. The FRS has two retirement plans from which you can choose to help you meet your retirement goals: the Pension Plan (defined benefit) and the Investment Plan (defined contribution). Each FRS plan is designed to provide you with a good foundation for financial security when considered along with Social Security, other retirement programs, and your own personal savings (such as savings accounts, IRAs, and deferred compensation programs offered through your employer, among other resources).

Clearly, the intent of the Florida Retirement System’s plans is to provide the means, when combined with Social Security and other sources of retirement income, for retirees to achieve and maintain financial security in retirement. The Florida Retirement System’s Investment Plan does an excellent job in meeting most of the identified best practices, like defaulting new employees into the defined contribution plan and providing a variety of affordable and flexible investment options.

The one glaring exception to this, however, is that the DC plan’s total contribution rate is woefully inadequate to fund a lifetime retirement benefit. For regular class employees—which constitute the majority of FRS members—the employer contribution is 3.3% of salary and the employee contribution is just 3% of salary. This total of 6.3% is effectively half of the 12% to 15% most retirement experts consider necessary to fund retirement (when combined with Social Security and the other sources of income as mentioned above). Because of this, the Florida Retirement System is not able to live up to its own stated objective of providing “a good foundation for financial security.”

While raising contribution rates is the obvious solution to this problem, doing so would be admittedly not cheap. Doubling the contribution rate is clearly an expensive proposition that cannot be treated lightly. Several factors should be considered when public pension systems are contemplating a contribution increase:

• The increases do not have to be accomplished all at once. A multi-year plan can be put in place to gradually increase the rates over several years.
• The increases can be split, in some combination, between employers and employees. The full burden need not fall on employers.
• In a defined contribution plan, the employer’s obligation is fully met when the contributions are made. In other words, the budgetary requirements are completely defined. There can never be any unfunded liabilities created so there is no budgetary unpredictability.

Not meeting the contribution rates necessary to properly fund retirement is not without costs either. As individuals arrive at retirement age following a career with retirement contributions of just 6.3%, even combined with the income from Social Security and other retirement assets, total retirement income will most likely be insufficient to provide financial security. Various high-cost state-provided social services may be necessary to help support the individuals in retirement. Alternatively, individuals might well postpone retiring because of the lack of sufficient retirement assets. In this instance, the reality is the employer would be unable to replace that employee with a younger, lower-paid one, and be left with higher costs and possibly lower productivity from an employee who really doesn’t want to be working any longer.

Even though the Florida Retirement System’s Investment Plan is a well-designed defined contribution retirement plan, the substantial contribution deficit effectively limits its ability to live up to its stated goals and threatens its long-term viability. While the solution is clear, it is not inexpensive. With effective budgetary planning, the Investment Plan can fully meet best practices and live up to the clear objectives stated by the FRS.

The post Florida’s public defined contribution retirement plan has a big flaw appeared first on Reason Foundation.

Since public pension plans smooth their asset returns over a number of years to manage market volatility, any properly risk-managed retirement-focused investment will somewhat underperform the market in up years but outperform the market in down years. For this reason, and others, any praise for the good investment results for public pension plans is justified and should not be dismissed. At the same time, while there is ample reason to be happy about excellent asset returns, there is also a danger that plan sponsors and retirement systems may sit back and rest on their one-year laurels.

Public pension plans should always examine an important question— Are the designs of their plans still working?

While the pressure to improve investment performance is somewhat, or temporarily, lifted, policymakers should take this time to focus on the retirement plan design issues that may be impacting their long-term ability to meet their primary objectives of enabling public employees to maintain a certain standard of living in their retirements after careers of public employment.

If pension plan sponsors do not examine the design of public retirement systems, it’s difficult to know whether things have drifted off course. This is especially important considering the changing career mobility of state and local government employees. According to the Bureau of Labor Statistics, the median tenure of a state government employee in 2020 was just 5.6 years. While this is longer than the 3.6 years for all private-sector employees, it is hard to escape the conclusion that workforce mobility and benefit portability issues for public employees are an increasing concern to their retirement security.

The Employee Retirement Income Security Act (ERISA) is the set of regulations governing private-sector retirement plans. While not directly applicable to the public sector, ERISA is often recognized as providing best case designs across all employment sectors. Many public plans have vesting periods longer than the ERISA maximums. Vesting forfeitures and the decreasing value of frozen deferred benefits for public employees who leave before retirement eligibility clearly have a large negative impact on employees’ retirement security. 

While no single plan design will perfectly meet the needs of all employees as well as all employers and taxpayers, some newer public pension system designs can effectively address today’s realities of employee mobility while still providing for lifetime income security.

The backbone of new retirement plan designs is the advancement in financial technological capabilities that enable defined benefit-like investment and lifetime income solutions to be utilized at the individual plan participant level. Technology enables this optimization approach to be provided to individuals at a low cost compared to what it would have taken some years ago to provide the same capabilities. With this new retirement optimization approach, individualized retirement savings and benefits can be structured to more effectively adjust to changes in an individual’s career and life circumstances and provide flexibility to select the level of lifetime income needed to reflect differences in expected longevity, dependent needs, and the availability of other financial and income resources. This will both better meet employee needs and better manage costs for employers and taxpayers.

The traditional “one-size fits all”  defined benefit plan long favored by public retirement systems falls short of meeting the retirement security needs for too many state and local government employees, particularly younger, newer employees. Now is the time for policymakers to aim higher by focusing on their current retirement plan designs. Failure to do so may mean that a retirement plan will continue to fall short in providing optimal retirement options to new public workers to the detriment of employers, employees, and taxpayers.

The post Amidst great investment returns, public pension systems should reassess plan designs appeared first on Reason Foundation.

While these very strong investment returns are great news for public workers and taxpayers, some may be tempted to say that this year’s good returns will be the long-awaited salvation for public pension systems that have struggled to recover from the 2008 recession, but that is hardly the case. Unfortunately, a year of great investment returns alone will not fix the years of underfunding and poor plan assumptions plaguing many public pension systems. One year of excellent returns should also not serve as a diversion from the future financial risks facing pension plans and the employees they were created to serve.

The real purpose of a state or local government pension plan is (or should be) to provide a stable income in retirement following a career in public employment that, when combined with other retirement income sources, enables the retiree to maintain something resembling their pre-retirement standard of living. Regardless of recent investment performance, governments, public employees, and taxpayers should be asking if traditional state and local government pensions meet the needs of the modern public employee workforce.

Public Retirement Research Lab’s 2020 “Trends in Public-Sector Employee Tenure” report notes:

“State workers had the shortest median tenure among the public-sector workers at 6.0 years in 2018, compared with 7.0 for local workers and 8.0 for federal workers. In contrast to federal workers, the tenure trends for private-sector, state, and local workers were relatively flat. Specifically, private-sector workers’ median tenure in 2018 was very close to its 2000 level (4.0 in 2018 vs. 3.9 in 2000), local workers’ median tenure was 7.0 years in 2000 and 2018, and state workers’ median tenure was slightly lower in 2018 at 6.0 years compared with 6.5 years in 2000.”

This emphasizes the fact that, like their private sector counterparts, the modern public sector employee is less likely to work for one employer for his or her entire career. In fact, today’s employee will typically have several employers throughout a career. The traditional defined benefit pension plan still favored by most state and local government employers may no longer suit the career mobility needs of the modern public workforce. In reality, this tenure trend is nothing new, but it remains unaddressed by most public pension systems. Retirement plan designs that are much more suited to meeting the portability of today’s public workforce are readily available and can be structured to address the legitimate concerns illustrated by trends of how often today’s workers change jobs.

State and local pension systems that have reported 2021 investment results thus far have had a median investment return of 27%—well above the 7.0% annual return rate assumption used by the median public pension system. As of this writing, the best return reported by a system with a June 30 fiscal year-end date has been the 33.3% return achieved by the San Bernardino County (California) Employees’ Retirement Association. The nation’s largest public pension system, the California Public Employees’ Retirement System, CalPERS, reported a 21.3% return, the lowest return reported thus far.

While these strong investment returns are very welcome and will reduce pension underfunding, they should also be viewed in the context of overall market returns. For the one-year period ending June 30, 2021, the S&P 500 returned 40.79%. A Vanguard Exchange Traded Fund (Ticker: VOO) designed to track the S&P 500, returned 40.77% for the same period, which means it was simple for an average investor to beat many of the experienced professionals managing large public pension funds. Even if a fund manager only invested 90% of assets in VOO and kept 10% in cash to pay benefits in the near term, he or she could have beaten the return rate of all the public pension systems that have reported 2021 results so far.

So, while we can and should applaud the improved market returns recently achieved by many public pension systems, it is important for the plans to see the returns as just one part of a bigger picture. These good returns alone do not guarantee better retirement security for public workers and policymakers and plan managers are still facing long-term economic forecasts that predict lower average investment returns in the decades ahead.

Generating positive annual investment returns is certainly one key element of a successful retirement plan. But public pension plans should also take this opportunity to ensure they are doing everything they can to provide the retirement benefits they’ve promised to workers and to protect future taxpayers from burdensome public pension debt. This is a time for many in the public pension world to examine and improve their investment strategies, look for opportunities to reduce the fees they pay, increase contribution rates where needed, and lower their assumed rates of return to more realistic figures that reduce risks. Making those types of pension reforms would do wonders to build upon one year of excellent investment returns.

The post Putting a year of good investment returns for public pension plans in perspective appeared first on Reason Foundation.

In 2018, Colorado enacted legislation designed to finally get a handle on the debilitating unfunded liability within the Public Employees’ Retirement Association (PERA) that had grown to over $50 billion. Reason Foundation’s Pension Integrity Project lauded the pension reform legislation as steps in the right direction. While the reform package was not perfect, it did lay the groundwork to make significant progress toward addressing the state pension plan’s growing debt. One of the key elements of the Colorado pension reform effort was making an additional $225 million annual contribution to PERA from the state’s general fund. 

But, due to the economic uncertainty the COVID-19 pandemic created early in 2020, Colorado lawmakers ignored the vital financial planning elements described above and took a deliberate one-year break from the $225 million contribution. As a result, Colorado’s public employee pension plan will miss out on not only the $225 million payment but also the long-term investment earnings the payment would have generated. Using the state’s assumed investment return rate of 7.25% percent, that money could have grown to $990 million in the long term.

As Axios reported, COVID-19 did not create the state budget problems that lawmakers expected:

A year ago, Colorado cut more than $3 billion from the state budget. Now, the state is showing a massive surplus that combined with the federal stimulus gives state leaders the ability to spend or save $9 billion.

Beyond the financial impact of the missed pension payment, it is also unfortunate that a good piece of reform legislation can be so easily negated, even if it was just for one year. Tremendous amounts of time and effort went into crafting a workable pension reform package leading up to the passage of the Colorado legislation. It should not be acceptable to taxpayers or lawmakers that the mandate of the 2018 law could be summarily dismissed by legislative fiat.

Colorado’s failure to meet the requirements of its pension reform illustrates one of the many pitfalls that face policymakers when managing defined-benefit pension plans. It is easy to sacrifice long-term priorities when faced with immediate challenges.

Generally, state lawmakers and public pension plan administrators focus on short-term needs over long-term commitments, which at times means forgoing pension payments. Over the long term, these missed pension payments have a significant impact on pension funds and increase the annual cost to both taxpayers and public employees. For Colorado, making annual contributions that were below what was needed added $4.6 billion to the state’s unfunded pension liabilities from 2000 to 2016.

Colorado policymakers should be mindful of this particular problem and should act to correct the impacts of the missed 2020 payment. One simple solution—especially with the state sitting on a massive surplus—would be a prompt make-up payment.

Reason Foundation analysis suggests that a $500 million cash infusion—enough to make up for the lost 2020 payment and add a buffer for any future economic uncertainties—would allow the state’s plan to adopt lower contributions for members and employers. This would mean nearly immediate savings for those parties.

Other policy options could slow the growth of pension liabilities and reduce the impact of missed contributions in the future. The Colorado PERA system offers a defined contribution option to all state new hires except for teachers. Defined contribution retirement plans eliminate the potential for unfunded liabilities. Additionally, the traditional defined benefit plan is the default choice upon hiring for new Colorado workers and this plan has the greatest number of participants. But less than 5% of new members earn a full, unreduced pension benefit due to the lengthy vesting period. Making the defined contribution retirement option available to all teachers and simply making it the default choice for new hires would reduce PERA’s funding risks going forward and would better fit the modern needs of public workers in the state.

Colorado’s one-year lapse in contributions will have a significant long-term impact. It is not too late, however, to double down on the goals of the 2018 pension reform package and adopt additional measures to further improve PERA’s funding.

The post Colorado’s Missed Pension Payment Could Cost Taxpayers Millions appeared first on Reason Foundation.

In recent years there have been several examples of cooperative retirement reform efforts that illustrate how maintaining a focus on today’s realities, like typical employment tenure and the amount of income needed for a secure retirement, can support public policy changes that both address the crippling public pension debt governments and taxpayers are facing while also creating an effective retirement plan for today’s modern workforce.

One such effort took place in the state of Rhode Island about a decade ago. Then-State Treasurer Gina Raimondo (now serving as U.S. Secretary of Commerce), took great pains to reach out to public employees across the state to better understand their needs. The state’s pension plan at that time was severely underfunded and at risk of complete insolvency. Raimondo’s outreach resulted in a bipartisan legislative success that produced a new retirement plan design, which addressed the state’s dire financial condition and provided current and future state employees a retirement plan that better meets their needs.

Another successful example of employee-focused pension reform took place with Arizona’s Public Safety Personnel Retirement System (PSPRS). In that case, Reason Foundation’s Pension Integrity Project worked closely with employee unions and state legislators to help design a flexible retirement plan that provided financial security for taxpayers and accounted for the needs of public safety employees.

More recently, this month the Texas legislature passed Senate Bill 321, which improved contribution policies to address the  Employees Retirement System’s $15 billion in pension debt and designed a cash balance retirement plan for future state workers that can effectively meet the needs of our highly mobile workforce.

These successful public pension reform efforts have several notable elements in common:

• They considered the realities of a modern, mobile workforce. Recognizing today’s work patterns and the needs of the employees also leads to a retirement plan that is designed to help governments appeal to and recruit highly qualified employees.
• Stakeholder groups, often at odds during pension reform efforts in other states, worked together to develop solutions in states with successful pension reforms. Putting aside ideological differences and focusing on the policy and practical issues facing employees and the states were critical in these successful reform efforts. For example, public employee unions are often unwaveringly dedicated to traditional defined benefit plan designs despite clear evidence that these plans are increasingly less advantageous to the career mobility needs of employees today. The other side of the same coin is that some legislators are convinced that the only meaningful reform involves completely replacing defined benefit pension plans with 401(k)-style defined contribution plans. The successful reform efforts in states like Rhode Island, Texas, and Arizona brought together stakeholders and retirement specialists to craft practical solutions that combine elements of both defined benefit and defined contribution plans to better meet the needs of all impacted parties.
• Finally, these pension reform efforts were successful because the efforts were centered around real, fact-based issues supported by data and realistic financial projections.

Unfortunately, many other pension reform efforts in state and local governments across the country have failed because they lack the elements mentioned above. Often these efforts were not successful because the impacted parties could not get past their ideological preconceptions to compromise or work together to address real issues, including ballooning debt, low employee retention rates, and employee career mobility.

Public pension reform efforts should always begin with the focus on how best to recruit and serve state and local government employees while meeting employer workplace needs in ways that are sustainable for taxpayers. These efforts should rely on current workplace trends where people frequently change jobs, rather than on outdated understandings of the public employment marketplace of decades gone by. With this as a starting point, all parties can move to help achieve comprehensive pension reforms that benefit employers, employees and taxpayers.

The post Succesful Public Retirement Reforms Are Collaborative, Helping Workers and Taxpayers appeared first on Reason Foundation.

The Michigan legislature is currently considering two bills (House Bill 4733 and HB 4734) that bring the existing defined contribution plans for K-12 school employees and other public workers more in line with current retirement industry best practices.

One of the most important defined contribution design best practices is to provide an investment line-up that is focused on long-term retirement savings rather than simple near-term wealth accumulation.

Another best practice is helping an employee to receive an income throughout their retirement that they cannot outlive. Just providing for a lump-sum distribution of assets at retirement and leaving the employee to “figure it out” from there is inconsistent with some of the very reasons to offer a retirement plan.

These design principles address the critical concerns of investment performance and longevity risks that must be tackled by any retirement plan that hopes to meet its objectives. The bills in Michigan are intended to address both of these critical areas.  The bills state:

“In addition to the categories of investments provided by the investment board under subsection (1), the retirement system shall offer access to 1 or more fixed annuity options and may offer access to 1 or more variable annuity options provided by an annuity provider selected under this subsection. While a qualified participant is employed by the employer, the annuity options offered under this subsection must allow a qualified participant the ability to purchase a fixed rate annuity and an annuity with a guaranteed lifetime income option, and may allow a qualified participant the ability to purchase a variable rate annuity. Subject to subsections (4) and (6), the investment board shall select 2 or more annuity providers based on a competitive proposal process.”

Adding fixed and variable annuities to the investment selections available under the DC plans addresses the need to have long-term investments available to participants. It helps move the Michigan retirement plan to one focused on lifetime income and not solely on maximizing asset accumulation.  Further, the bills specify that a qualified participant must have the ability to purchase an annuity with a guaranteed lifetime income.

The key is that this provision enables the ability to purchase the lifetime income from within the plan during an employee’s time of service.  Without this ability, a participant wanting a lifetime income annuity would be forced to take a lump-sum distribution at retirement and then purchase an annuity on the spot market, where economic conditions may not be favorable.  Being able to purchase future income throughout the asset accumulation stage of a career and then convert to a lifetime payout annuity could very well result in better retirement outcomes.

Michigan’s defined contribution retirement plans have evolved over time and adopted a range of best practices for a well-designed public sector primary DC retirement plan. The improvements addressed in House Bill 4733 and HB 4734 would continue that tradition of ongoing retirement plan enhancement.  The investment offering and lifetime income provisions are two of the most important and impactful design elements in any retirement plan.  The improvements in these areas addressed in these bills greatly impact an employee’s ability to have a financially secure retirement, which also helps employers meet their recruiting and retention goals.

The post Annuity Offerings Can Help Improve Michigan’s Defined Contribution Retirement Plans appeared first on Reason Foundation.

If enacted Senate Bill 176 will close the current South Carolina Retirement System (SCRS) defined benefit plan to new entrants after June 30, 2021, and provide new hires a choice between a new “Shared-Risk Defined Benefit” pension plan and an improved version of South Carolina’s Optional Retirement Plan (ORP). The ORP, the defined contribution plan currently offered in the state, would be redesigned and renamed the “Wealth Builder – Primary Retirement Savings Plan” (WPRS) and would be the default retirement plan if an employee does not choose to opt-out of the plan within 60 days.

Since WPRS would become the new default retirement plan, it is important to assess its adequacy and ability to meet the needs of retirees and employers. Upon review, the Pension Integrity Project finds that the proposal reflects a high-quality retirement plan design that incorporates best practices from national experience.

While decades of experience with public sector defined contribution (DC) plans have demonstrated that they can be an effective means to providing adequate retirement income for public workers, not all DC plans meet the definition of an effective retirement plan.  There are a number of straightforward plan design principles that when carefully incorporated into DC plans serve to create a sound retirement plan that meets the needs of employees and employers.

The proposed WPRS retirement plan conforms to most of the best practices of public sector defined contribution plans, and other elements could be addressed to ensure the plan is as effective as possible.

Senate Bill 176 importantly avoids a shortcoming of many retirement plans by providing a formal statement of legislative intent and plan objective for the WPRS that is consistent with retirement best practices:

“The intent of the General Assembly is for the State of South Carolina WealthBuilder-Primary Retirement Savings Plan (WPRS) to be the primary retirement plan for participants of the state’s retirement system. The objective of the WPRS is to provide participants with a path towards having a secure retirement through a focus on lifetime retirement income in order to maintain a participant’s standard of living, following a full career of employment.”

This formal declaration of plan intent and objective is a critical guideline for the administrative and investment fiduciary for the WPRS and provides clear direction to the Public Employees Benefits Association (PEBA) as the plan administrator for the WPRS and the South Carolina Retirement System Investment Commission (RSIC) under PEBA, which is responsible for the investment structure.

The WPRS also satisfies the critical best practice of automatically enrolling eligible employees into the plan as well as providing adequate contributions. Retirement experts agree that a total contribution rate of between 10 percent and 15 percent is necessary over a career to adequately fund retirement (when combined with Social Security and personal savings). The WPRS contribution design of 16 percent (9 percent employee; 7 percent employer) for most employees would meet these best practice contribution standards.

The bill also allows an auto-escalation feature that would increase employee contributions by up to 1 percent per year up to a maximum employee contribution of 15 percent. The employer will also make matching contributions up to 2 percent for employee contributions made above 5 percent. If an employee maintains their default contribution, this would automatically trigger the full 7 percent employer contribution.  However, employees are allowed elect a minimum employee contribution of 5 percent, and if they chose to do so, the resulting 10 percent aggregate contribution rate that would still fall within the lower bound of benefit adequacy. That said, a higher floor for employee contributions, such as 7 percent, might be warranted to secure the ability to fund lifetime financial security in combination with Social Security and reasonable personal savings.

The investment structure for the WPRS has not yet been established. However, SB 176 does provide substantial guidelines by authorizing the use of a wide variety of investments under the plan including annuities, mutual funds and other similar investment products and professionally managed portfolio options. If these guidelines are followed there is a strong likelihood the retirement plan will provide a variety of investment options and allow participants the ability to create a portfolio that best meets their retirement needs.

One potential area of divergence from best practice is the multiple vendor configuration of the state’s current ORP, which would be retained under the WPRS. Vendors are the wealth management and financial firms that states contract to administer and manage defined contribution assets and benefits.  The large number of plan provider options currently offered in the ORP may be confusing for employees, and the current level of complexity is not necessary nor considered a best practice.  If the multiple vendor configuration is continued for the WPRS it is important to consider additional educational steps to ensure employees know what retirement income services each vendor provides.  For example, not all the vendors currently offer lifetime annuity solutions.

Under the proposed legislation, accumulations attributable to employer contributions into the WPRS are vested in the employee 20% per year with full vesting after 5 years of service.  This is a substantial change from the current 100% immediate vesting of the ORP.  While 5-year graded vesting is longer than desired, it is still shorter and provides better portability than the DB plan’s 8-year cliff vesting. Nonetheless, full and immediate vesting is best practice and would be preferred.

The distribution methods offered under the WPRS will depend on the vendor but will generally include annuities, full or partial lump-sum withdrawals and periodic payments.  SB 176 also requires at least one vendor provide lifetime fixed and variable annuity products but does not include a provision allowing PEBA or an employer to require annuitization of some or all assets.  This creates more flexible retirement income choices for employees, which is valuable, this approach also increases the chance that some employees may outlive their retirement assets from the plan.  PEBA and RSIC can address this shortcoming by emphasizing the income-focused and annuity options being provided and considering lifetime income investment options as the default.

Disability coverage in the WPRS is the same as in the DB pension plan. This is an improvement over the current ORP structure, which provides no disability benefit for ORP members. Employers are required to make separate contributions to help fund the benefit.  While the consistency between plans is good, the DB disability benefit is not available until an employee has eight years of creditable service, which seems excessive and not in line with best-practice standards.

Overall, the new default WPRS has an excellent foundation upon which to build a sound and effective modern retirement plan for public employees in South Carolina.

Full Senate Bill 176 Scorecard 

The post Evaluating South Carolina’s Proposed Defined Contribution Retirement Plan appeared first on Reason Foundation.

Currently, the North Dakota Public Employees Retirement System (NDPERS) has a traditional defined benefit (DB) pension plan for most state and local government employees but also offers to a limited set of state employees the choice of electing to participate in a defined contribution retirement plan instead of the pension plan.

The optional NDPERS DC plan was available to most employees from 2013 to 2017, but effective August 1, 2017, the special enrollment period to all permanent employees ended and plan eligibility returned to just a limited number of employees. With the legislature poised to potentially take a major step by making this optional DC plan the primary retirement plan design for most new state workers outside of higher education, public safety and the judiciary, this analysis examines how well the current North Dakota DC plan meets certain best practice retirement plan design principles and where it may fall short on others.

Strong Contributions Create Foundation for Employee Retirement Security

The greatest strength of the NDPERS DC plan is in its contribution policy. Employee contributions are 7 percent of salary (4 percentpicked-up by the employer and only 3 percent deducted from payroll). Employer contributions are 7.12 percent of salary. This total 14.12 percent of salary adequately meets the contribution recommendations by many retirement experts for non-safety employees, especially considering that participants in this plan are also in social security. This is a contribution schedule that, over a career of employment and combined with Social Security and personal savings, will produce a retirement income that allows plan participants to maintain their pre-retirement standard of living.

One consideration worth noting is that the DC employer contribution of 7.12 percent is the same as in the DB pension plan. While the rates between the two plans are not linked statutorily, the legislature should make clear that there is no link between the contributions in the two plans; different factors and policy considerations are used to determine the proper contribution rates in  DB and  DC plans so it is never a best practice to have the two linked.

Areas for Improving the Current Defined Contribution Plan

Outside of the strength of plan contributions, several important areas of the NDPERS DC plan are not consistent with best practices in DC design. The first among these is unfortunately common in many retirement plan designs today. Plan objectives are not fully and clearly defined in the governing statutes nor any material that participants or others can easily access. In the Statement of Investment Policy for the DC plan, NDPERS states, under Objectives of the Plan, that, “The Plan is a long-term retirement savings option intended as a source of retirement income for eligible participants.

Without a more comprehensive statement of objectives, it is not surprising that the current DC plan lacks certain features that would help it better meet employer and employee long-term retirement needs. It is also impossible to measure the plan’s effectiveness if its very objectives are unclear.

For the sake of this analysis, the objective of the NDPERS DC plan should be to meet employer workplace needs in the recruiting and retention of qualified workers and for the maintenance of an employee’s standard of living through retirement, in combination with Social Security and personal savings, following a full career of employment. (Note that this statement does not specify that the “full career of employment” is with one employer.)

The objective should further include that this benefit is provided in a cost-efficient way without the creation of unfunded liabilities. Preferably, the actual statement of objectives would be comprehensive and detailed enough to include specific income replacement goals and cost targets.

Perhaps the greatest shortcoming that is evident regarding the North Dakota DC plan today is that its very existence may not be clear to those eligible to participate in it as there is very little marketing or promotion of the DC plan.

The DB plan is referred to as the “main” retirement plan, implying, if not outright stating, that the DC is a lesser option. If the current legislative discussions result in defaulting most new hires by the state into the DC, both NDPERS and state employers will need to develop robust ways of helping to articulate the benefit to new hires and communicate the value of this option to those entering the retirement plan.

Improving the Investment and Distribution Options for Participants

Plan investments available in the NDPERS DC plan present a mixed bag of positives and negatives. To the system’s credit, they offer a solid mix of investment funds with acceptable fees and also have a series of target-date funds, also well priced, for participants preferring a “one-choice” option. The number of available funds is not overwhelming nor is it repetitive.

On the downside, there are no deferred annuities offered in the investment menu thereby limiting employee flexibility in preparing for retirement income. Also, it would be preferable to see some guaranteed investments included in the target-date portfolio constructions, again enabling better retirement preparation for participants.

Additionally, asset distribution options available under the DC plan are not consistent with a retirement plan designed to meet the key objective of predictable and stable post-employment income. The standard distribution method offered under the DC plan is a lump-sum withdrawal upon separation from service. The employee can roll this distribution over to an IRA or take periodic distributions. Lifetime annuity purchases are only available by the employee purchasing such annuity on the open market with the lump-sum distribution.

While common, these distribution choices limit the attractiveness of the DC plan as a core retirement plan. The plan sponsor could require annuitization of some or all assets (as they do in the DB plan) but they do not, effectively treating the core DC retirement plan as a supplemental savings plan. DC plans can do better in terms of operating as a true core retirement plan and meeting lifetime income security for employees.

Benefit portability is a key strength of most DC plans. That, however, is limited in the NDPERS DC plan. Savings attributable to employer contributions are vested for the employee over four years of service. This vesting schedule is not ideal and inhibits retirement benefit portability. Full and immediate vesting would be preferred. This schedule also treats defined contribution plan participants less favorably than the DB plan, which vests over three years. The DC vesting period should be reduced from its current level to enhance portability and value for the state’s future workforce.

Improved Disability Provisions Needed for Plan Participants

Finally, the DC plan does not include provisions for disabled employees other than giving them the ability to withdraw assets from the plan. A simple solution to this deficiency would be for the plan sponsor to slightly lower the employer contribution (likely by less than 50 basis points) and purchase insured disability benefits for all participants in the DC plan.

Conclusion

Overall, the NDPERS DC plan has a solid foundation with its excellent contribution rate.  With a few simple changes that would add little if any cost to the state, North Dakota’s DC plan could become a model for public retirement plans across the country.

The post Evaluating North Dakota’s Defined Contribution Retirement Plan for State Employees appeared first on Reason Foundation.