The National Institute on Retirement Security released in February a resource guide highlighting the results of three case studies that show problems in a defined benefit plan can be exacerbated by moving new hires to a defined contribution scheme.
In fact, the NIRS analysis found that retirees receive the same amount of lifetime income from their pension that they could get from a typical DC plan for about half of the cost. Defined benefit plans that are already plagued with underfunding problems, it seems, carry those issues over to defined contribution plans.
NIRS studied three state pension plans and identified three trends:
- Existing underfunding problems did not improve following a switch, and costs increased.
- Workers in the new DC plan also struggled to save enough for a secure retirement, and frequently didn’t.
- The best way to address underfunding is to establish a responsible funding policy and stay disciplined about making the full contribution each and every year.
Here is NIRS’ analysis of the three states:
Five years ago, Alaska’s Public Employees Retirement System (PERS), Teachers Retirement System (TRS) and retiree medical plan were facing a combined $5.7 billion unfunded liability. To try to address that liability, the state adopted a mandatory 401(k)-style retirement plan for state employees hired after July 1, 2006.
Instead of correcting the problem, though, the new plan increased underfunding by 20% in 2006, and as of 2013, the combined liability reached $12.4 billion. Participants in the PERS plan contributed 47% of what was required annually to the plan; TRS participants contributed 45% of the annual required contribution.
The demographics of the plan also changed, according to NIRS’ analysis. In 2013, PERS had almost 30,000 retirees, but was collecting contributions from less than 21,000 members. TRS was paying over 11,700 retirees, but only collecting from 6,352 participants.
In 2007, regulators started to introduce bills to reopen the pension plans to new employees, but none of those bills have been passed.
“Losing a significant percent of employees to the DC plan reduced the one steady source of pension funding in Alaska,” according to NIRS. “The false promise of the DC switch may have led policymakers to continue to underfund the pension plans, which only worsened the problem.”
The Michigan State Employees’ Retirement System (MSERS) closed its doors to new hires in 1997, opting to provide those workers with a 401(k) plan with a 4% automatic contribution and a 100% match up to 3%. Employees could contribute up to 7%. Workers already enrolled in MSERS were given the option to switch.
In 1997, MSERS was actually overfunded, NIRS found, but by 2012, the funded level fell from 109% to 60.3%. NIRS noted that there were two significant downturns in that time, but that doesn’t fully explain the dramatic drop in funded level. NIRS found that between 2012 and 2013, despite a 12.5% investment return that year, the unfunded liability grew by over $71 million to $567 million. Markets have since improved and the state is making larger payments, but the aging population of the plan means it’s still underfunded. The annual required contribution for each participant in 1997 was just over $4,000. By 2013, it was almost $37,100 per active employee.