A Wake-Up Call for Public Pension Systems
For decades, public pension systems have been doling out more than they take in. Labor unions have stymied reform efforts, but the latest estimates of the public pension gap may finally serve as a wake-up call.
A new study from Moody’s Investors Service, the bond credit rating business, reports that the level of unfunded liabilities for the 25 largest state and local U.S. public pensions is now more than $2 trillion. The gap is more than three times higher than it was just a decade ago.
The rapidly rising pension gap is not caused by the weak economic recovery. Average investment returns for the 25 biggest public pensions systems over the past decade were only two-tenths of a percentage point below expectations. Instead, Moody’s identified inadequate pension contributions and the inevitable demographic shift towards an aging population are the main factors behind the growing pension gap. The report acknowledges what has been known for quite some time — pension forecasts use actuarial tricks to hide the dire storms that are about to hit pension systems.
No one wants to see pensioners live poorer lives, caused by broken promises and bankrupt pensions. The public pension system’s integrity must be protected with common-sense reforms that acknowledge the reality of the constantly growing pension gap. The ideal reform for struggling pension systems would be a switch from defined-benefit to defined-contribution pension plans.
Under defined-benefit plans, benefit payments are often calculated by a complex formula accounting for years of service and average salary. Vesting rules trap workers in their jobs because the pension is not portable; if workers leave, they often don’t receive a pension. Plus, it is not uncommon for a public employee to receive a generous promotion or salary increase just before retirement in order to spike the employee’s pension benefits.
With defined-contribution plans, benefits are calculated based on how much employees contribute to the pension system. Employees choose how much money is put in the account and where it is invested, within reasonable restrictions. Employers do not bear the burden of long-term pension obligations, while employees benefit from portable pensions, enabling them to move up the career ladder as opportunities arise.
The disadvantage of the defined-contribution plan is that workers have to be self-disciplined and roll over lump-sum pension savings into retirement accounts when they change jobs. Some workers spend the lump-sum payment instead of saving it for retirement. There is no reward to the investment if it is spent at every job change. Even with their disadvantages, defined-contribution plans are more fiscally sustainable than defined-benefit pensions.
If states cannot move to defined-contribution plans, they have other reform options. Benefits could be capped at a maximum amount of salary. Loopholes that allow for double-dipping, where an employee simultaneously collects a pension and works a second government job, could be closed. Retirement ages and employee contributions must both see gradual increases, so as to acknowledge the reality of Americans’ expanding life expectancy and its associated pension deficit.
Reasonable pension reform proposals are protested loudly by public sector workers, who then start donating to accommodating politicians. Cities and states will needlessly harm retirees if they do not see a $2 trillion pension gap as a call for reform. Now is the time to embrace common-sense improvements that close abusive loopholes and empower individual public-sector employees to make their own retirement decisions.
Jason Russell is a research associate at Economics21 at the Manhattan Institute for Policy Research. You can follow him on Twitter here.
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