In states that have switched their employee retirement plans from the defined benefit approach to a defined contribution option, costs and levels of retirement insecurity have both increased, rather than fallen.
That is the conclusion of the National Institute on Retirement Security, based on its examination of the performance of three states that shifted away from traditional pension plans: Alaska, Michigan and West Virginia.
The Washington, D.C.-based institute said it undertook to the study to address a "misperception (that) persists among some that defined contribution plans save money when compared with traditional pensions."
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The state-by-state details, according to the NIRS:
- Alaska voted to make its switch in 2005, with legislation moving all employees hired after July 1, 2006 into a DC plan. This was meant to slow the growth of a $5.7 billion unfunded liability for its two defined benefit pension plans and retiree health care trust. As of 2014, the state's unfunded liability had spiked to $12.4 billion. Alaska recently introduced legislation to return to a defined benefit model.
- Michigan closed its pension plan in 1997 in an effort to save money at a time when the plan was overfunded at 109 percent. By 2012, the funded status had fallen to 60 percent. The two large financial crises since 1997 help to explain the drop. However, the state's unfunded liability has continued to grow even as markets have rebounded. According to the study, the required payment on Michigan's unfunded liability increased by $71.6 million to nearly $567 million between 2012 and 2013, despite a 12.5 percent return on investments during that period. A 2011 report found that the average defined contribution balance for Michigan government workers would at current annuity rates provide a benefit of only $8,200 per year, whereas defined benefit plans offer benefits of over $20,000 per year.
- West Virginia in 1991 moved all newly hired into its education system from its deliberately underfunded defined benefit program, the West Virginia Teachers Retirement System, to defined contribution plans. But by 2005, the average defined contribution account balance was a meager $41,478. So, in 2008, the state reopened TRS to new hires and became more disciplined about funding the plan. As of July 1, 2013, the funded level for TRS was 58 percent. The switch back to defined benefit was anticipated to cost the state $78 million, but is now expected to save it $22 million.
The NIRS says governments can do better with DB plans, thanks in part to higher investment returns due to professional management and lower fees.
"These case studies are important cautionary examples for policymakers examining retirement plans in their states," Diane Oakley, the institute's executive director, said. "It's clear that closing a pension plan to new employees doesn't fill overdue funding gaps or reduce the cost of providing employees' pensions, and in fact has had the exact opposite effect of increasing costs to taxpayers."
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