State and local government retirement systems have maintained defined benefit pensions as their main retirement plan design, even as the private sector has gravitated toward defined contribution plans.
How do public DB pension plans stack up when it comes to Americans’ top two priorities with regard to their retirement finances: reliable, adequate retirement income that will not run out and the ability to move retirement plans from job to job?
Just fine on both counts, according to a new report from the National Institute on Retirement Security, a non-profit research and education organization.
The NIRS research found that nearly all public retirement systems offered DB pensions that provide a modest but stable retirement income that lasts through retirement.
As well, almost all state retirement systems have features that allow for preservation of retirement income benefits even for employees who change jobs.
State and local governments have stayed with DB pensions, the report said, because these plans are highly cost-efficient and enable public employers to recruit, retain and retire a qualified work force that often values retirement benefits over higher pay in the private sector.
“One pervasive misconception about public DB pensions relates to the benefits when an employee leaves a job before retirement,” NIRS executive director Diane Oakley said in a statement.
“Our research finds that most public pensions have adopted retirement plan features that allow employees who change jobs to not only retain benefits, but also to increase retirement benefits.”
The NIRS surveyed 89 public pension plans around the U.S. to determine plan types, employee contribution rates, vesting requirements, interest rates paid on withdrawn employee contributions, refunds of member accounts, redeposits of employee contributions and ability to purchase service credits.
For systems that did not reply to the survey, researchers obtained data from the Public Plan database, National Association of State Retirement Administrator reports and public pension plan web sites.
According to the report, the private-sector switch from DB to DC plans, which has shifted the risk and most of the funding burden onto individual employees rather than experienced professionals and employers, has resulted in a median retirement balance for all working-age households of only $2,500, and just $14,500 for households near retirement.
The report acknowledges that employees value the ability to move their DC account balances from one plan to another when they change jobs, but notes that many fail to roll their balances into a new plan, and instead cash out their account balances, “which helps to contribute to the dismally low account balances Americans experience as they get close to retirement.”
Financial experts, the report notes, often recommend that individuals start saving early in their careers, do so consistently during the course of their careers and preserve retirement benefits during job transitions.
According to NIRS research, nearly all public retirement systems consistently require employees to contribute toward the cost of their retirement benefits as soon as they start working and to continue with every paycheck. If employees leave after just a few years, they can request a refund of their contributions.
“DC plans often are touted for offering portability, or allowing employees to move their account balances from job to job,” Oakley said. “But in reality, many employees fail to redeposit their retirement savings into a new plan, often just cashing out and using the money for other purposes.”
These cashouts, she said, resulted in $81 billion in lost retirement savings in 2014. Moreover, with regard to having a guaranteed lifetime income option, “only a very small percentage of 401(k) DC account holders choose that payment option.”
Eighty percent of the public retirement systems surveyed offer new members a DB benefit plan, and 11% offer a DB benefit in combination with a DC account.
Only 5% of systems provide only a DC benefit.
Many public pension plans have adopted features that allow individuals who change jobs to retain and even increase their benefits. Seventy-one percent of the plans surveyed credit their members with interest on their contributions if they leave and request a refund, at an average rate of 3.9%.
Most plans allow their members to later rejoin a system and repay their refund with interest, at an average rate of 6.5%, and most plans also allow separated members the option of leaving their account balances with the plan so that it can continue to earn interest.
Nearly all public DB systems allow members to purchase additional service credits to increase their pension benefits in retirement. Specifically, all public DB plans allow for the purchase of service credits for prior military service, and 59 of the plans surveyed allow for the purchase of credits for prior out-of-state government service.
Some plans allow for the purchase of credits for other specified types of service and leave:
- Prior federal government service, 31
- Personal leave/maternity leave, 45
- Out-of-state or in-state private school service, 16
- AmeriCorps, Peace Corps or VISTA public service, 19
Several plans have features that increase benefits for short- or moderate-term employees. Modifications include increasing the value of the deferred annuity benefits paid to former employees, rewarding employees who choose to keep their member accounts in the plan with interest and providing even higher matching amounts.
These features can encourage workers who leave before retirement to preserve the lifetime retirement income benefits they have earned, rather than spend their refund, the report said.
— Check out How to Spend, and Pay Taxes on, Your 401(k) on ThinkAdvisor.