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401(k)s Are a Bad Bargain for States

2/12/2015
Billionaires like Gov. Rauner and CEO’s in the 1 percent argue that the best way to fix Illinois’ pension funding crisis is by switching to defined-contribution (401k) pension plans that put workers’ hard-earned retirement security at risk. But a new study proves that couldn’t be more wrong.

Defined-benefit plans like those in Illinois provide fixed benefits, while 401(k) plans leave every penny at the whims of Wall Street. Rauner and his wealthy friends say the switch would save the state billions of dollars.
 
Wrong again, Rauner. The National Institute for Retirement Security (NIRS) conducted case studies on three states (Alaska, Michigan, and West Virginia) that switched to risky 401(k)s. They found that change came at a high price– literally.
 
Alaska is a case in point. From the study:
Although the DC switch was sold as a way to slow down the increasing unfunded liability, the total unfunded liability more than doubled, ballooning to $12.4 billion by 2014….Legislation has been introduced to move back to a DB [defined-benefit] plan.
Reuters reported that:
One problem in Alaska, critics of the switch said, was that the old pension plans still had to pay out pension benefits to workers hired before 2006, but lacked contributions from new workers.

"I voted against the change, and now the state has had to come in with a bailout. It's exactly what I said would happen," said Mike Hawker, an Alaska Republican assembleyman.

These plans are clearly disastrous for states, and they seriously jeopardize the retirement security of public workers. Defined-contribution plans:

  • Do not guarantee benefits
  • Earnings depend on the fluctuating market
  • Cost more in investment fees to the member than DB plans
  • Benefits terminate when the money runs out

Americans are increasingly failing to save for retirement during tough economic times. For the 80 percent of Illinois public employees – and the overwhelming majority of IFT members – who don’t receive Social Security, switching to a risky defined-contribution plan could leave them with no retirement safety net at all.

With so much at stake for workers and states, the NIRS report issues a warning to states considering making the change from defined-benefit to defined-contribution, and offers a better solution.

The case studies indicate that the best way for a state to address any pension underfunding issue is to implement a responsible funding policy with full annual required contributions, and for states to evaluate assumptions and funding policies over time, making any appropriate adjustments.

If that sensible answer sounds familiar, it’s because IFT and other unions have been saying it all along. Switching to a defined contribution system is not only bad public policy for the future, it doesn’t address the debt we have today. As Michael Carrigan, IL AFL-CIO President, wrote:

…moving public workers to 401(k)-style accounts will not fix the unfunded liability problem Illinois faces. In fact, such a move will likely increase the state’s pension debt, as it will reduce revenue in the form of employee contributions going into the pension funds and lower investment returns due to the change in the makeup of participants.

The problem with pensions in Illinois is a creation of politicians who spent years underfunding the system, essentially using the retirement savings of public workers as a credit card to pay for other priorities while ratcheting up state debt.

But it makes no sense to use the past misdeeds of politicians as an excuse to switch public employees to an inferior, less cost-effective retirement plan. Instead, we need to find ways to strengthen Illinois pensions for future generations.

 

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