3 States That Shuttered Pension Plans and Paid for It: NIRS

Participants in the DC plan aren’t much better off, according to NIRS’ analysis. As of 2013, 33,000 state workers, about two-thirds, were participating in that plan, but a 2011 report estimated an average benefit of only $8,200 per year.

NIRS found that even when participants in the DC plan contribute enough to receive the full employer match, the DB payout is greater and costs less. For example, an employee who starts at $40,000 a year, receives 2% wage increases and 6% investment returns each year for 25 years, would end up with about $288,000. That gives them about $1,600 a month, compared with $2,050 from a DB plan, according to NIRS. Furthermore, the cost of the DB plan is about 8% of pay, while the DC plan costs 10% of pay between the employer and employee contributions.

That shouldn’t be a surprise, NIRS noted in its report, since pooling employees in DB plans provides more economies of scale. “Specifically, they save money due to longevity risk pooling, maintaining a more balanced portfolio over a longer time, and achieving higher investment returns due to professional management and lower fees. NIRS has found that for a given level of retirement income, a typical DC plan costs 91% more than a typical DB plan.”

West Virginia

West Virginia’s Teachers Retirement System (TRS) had suffered underfunding problems at least as far back as 1979, NIRS found, with the state and many school boards failing to even match employee contributions in some years.

In 1991, the state closed TRS and moved new teachers to a DC plan, overlooking the fact that unfunded obligations aren’t reduced when new members leave the DB plan. In 2005, there were nearly 27,000 retirees receiving benefits from the plan with just 18,000 making contributions, and the funding level had fallen to a very painful 25%.

As in the Michigan example, DC participants weren’t doing much better. At the end of April 2005, the average balance was less than $41,500 and less than 6% of teachers over 60 had $100,000 or more in their account.

The state began re-examing the cost of the switch in 2003 and by 2005, decided to move new hires back into the DB plan. The state had found that the cost of benefits accrued in one year in TRS was about half of that in the DC plan.

Furthermore, the state started making additional contributions to make up for the underfunded years. In 2006, the state made an additional $290.1 million contribution. The following year, it contributed an extra $311.8 million and $807.5 million from a tobacco bond securitization.

The plan was reopened to new hires in June 2008, and teachers who had been hired into the DC plan were given the option to switch to TRS. Almost 79% decided to do so, including 76% who were under 40. The influx of young participants saved the state about $22 million, according to NIRS.

As of July 2013, the pension plan more than doubled its funded level to 58%. NIRS noted that it’s expected to be fully funded by 2034.

“Ultimately, moving from a DB plan to a DC plan can have dire consequence for employees, employers and taxpayers — even when a large unfunded liability exists,” according to NIRS.

The NIRS analysis noted that the financial crisis led all states to make “significant changes” to their retirement plans. “As states and municipalities have considered switching from the DB pension to a DC plan, those that have conducted a cost analysis have found that the move would save little to no money in the long term, and could actually substantially increase retirement plan costs in the near term.”

— Check out Top 20 Countries for Retirement Security: 2015 on ThinkAdvisor.