Private, Portable Public Employee Pensions May Help States Stay Solvent

By Greg Smith, Esq.

The following article originally appeared in the August 1997 issue of the Georgia Policy Review. Reprinted with permission from the American Legislative Exchange Council.

On May 30 the American Legislative Exchange Council’s (ALEC) National Task Force on Commerce and Economic Development adopted the model Public Employees’ Portable Retirement Option Act (PRO).

The new model bill could not only revolutionize the structure of public employee pension funds, but may also pave the way for privatization of the nation’s Social Security system.

In most states, public employees are promised specific benefits upon retirement based on their previous earnings and term of service. However, such defined benefit plans are now recognized as old-fashioned and inconsistent with the needs of the modern workplace. Under defined benefit plans, workers cannot even qualify for retirement benefits until they have vested in the plan. Typically, this means that a worker must put in at least 10 years of service before he or she can even qualify. If employees leave public service before that, they have no claim to their retirement benefits. In an age where workers are highly mobile, these inflexible plans act as an impediment to workers being able to effectively plan for their retirement.

Under ALEC’s new model bill, public workers would instead have the option of receiving a defined contribution from the government and investing that money in a retirement plan, such as a 401(k). According to a soon-to-be-released ALEC paper by Peter Ferrara, General Counsel and Senior Economist for Americans for Tax Reform, the number of private sector employees participating in defined contribution plans increased 300 percent from 1975 to 1995. By contrast, the public sector has remained tied to the outmoded defined benefit plans, with 91 percent of public sector employees participating in such plans in 1994.

Under a defined contribution plan, once a payment is made to the worker, it stays with the worker and is fully portable when the employee changes jobs. Furthermore, according to California State Assemblyman Howard Kaloogian, sponsor of a PRO bill in the Assembly and a leader of the movement as well as ALEC’s California State Chair, defined contribution plans result in better benefits to employees at a cheaper price to taxpayers. Everyone wins with defined contribution plans: both the taxpayer and the worker.

Late last year, Michigan Governor John Engler took Kaloogian’s idea and managed to pass sweeping pension reforms in Michigan. Under the bill, all new state employees hired after March 31,1997, and new public school employees hired after July 31, 1997, will be in the new defined-contribution plan. Current employees have the option of staying in the current system or switching to the defined contribution plan.

Under the new plan, Michigan contributes 4 percent of a worker’s salary to individual investment accounts for each worker. The state will also match additional voluntary employee contributions up to 3 percent of salary. Workers also have the option of contributing even more to the account, although the state will not match the excess.

Not only has this concept led to greater flexibility and personal choice for employees, but it also promises to add greater certainty to state budgeting. Unfunded pension liability has become a real threat in many states. According to projections by Wilshire Associates, Inc., many states, including West Virginia, Maine, Oklahoma, Louisiana and Illinois, have only enough assets in state pension funds to cover less than 60 percent of future pension obligations. In the end, taxpayers are the ones who will shoulder this unfunded burden. Under a defined contribution plan, this burden can be avoided entirely.