The current government employee-pension liability is causing many states, counties and cities throughout the United States to be on the verge of bankruptcy[1].  The liability arises because government employees have defined-benefit (DB) pensions – guaranteeing retirement benefits often times more generous than the private sector’s retirement plans.  The government pension funds lost much value during the past few years when the housing market collapsed.  Some government retirement programs are also overly generous.  Consequently, today many governments have insufficient funds to cover the cost of the pensions.  This means governments must increase their contributions into these retirement funds to meet their obligations and that means either increased taxes, cutting other government programs or expecting economic growth to be so strong as to provide the needed government funding without taking one of the first two actions.

However, an optional defined-contribution (DC) plan could be initiated into which the government employees, state governments, as well as county and city governments would contribute to a 401k-type plan.  Crafted properly, a defined-contributions plan would benefit the employees.  In addition, governments (i.e., taxpayers) would not be liable for paying guaranteed pensions even during recessions and depressions.  These new 401-K type retirement plans would be owned by the government employees just as they are owned by employees in the private sector.

This report compares the pension benefits that Fairfax County employees receive under the current defined-benefit plans[2] with those that would be received under a new defined-contribution plan.

The Fairfax County employees can experience many advantages from a defined-contribution retirement plan as compared to the present defined-benefit plan.  For example, in the employee’s early years, when the financial needs of the employees are high, they can put less into the pension fund (contributions are voluntary) so they can receive more in “take-home-pay.”  The employees can then qualify for a higher mortgage because their take-home-pay is higher (and a home is usually a good retirement investment).  Or they can pay off credit cards and other debts more rapidly.  Later, the employee’s offspring can inherit the funds because the funds are owned by the employee, not the government.

The arguments against  a  defined-contribution plan are two-fold: (1) the employee is not guaranteed the pension amount offered under the current defined-benefit program,  and (2) the employee will be unable to match the return on investment (ROI) realized by the defined-benefit plan.  The first objection is well founded.  It is this Defined-Benefit-plan guarantee that is causing much of the problem with public-sector pension funds.  As our citizens live longer and as the economy encounters a recession, the DB plans become underfunded.  This underfunding requires raising taxes, reducing spending in other government programs, or holding off such decisions in hopes that the economy significantly improves and the DB plans become financially strong.  The second objection could be circumvented by allowing the defined-contribution plan to invest in the same defined-benefit portfolio so the ROI is exactly the same.  Alternative investments by employees in a DC plan can, however, yield a higher ROI (see Appendices A and B).  If the economy is good, the ROI’s are high and the employee with the defined-contribution plan benefits tremendously.  A high ROI in the defined-benefit plan helps the employer (i.e., the taxpayer) since the retirement obligation remains the same but the retirement fund prospers.  (In practice, years of high ROI in government defined benefit programs are followed immediately with the government increasing the benefits. Thus the retirement benefits are greater, so, in reality, the taxpayer has not been getting tax relief from the ROIs during good economic times.)

This paper suggests that employees be given the option between the current defined-benefit plan and a new defined-contribution plan.  Employees would need to be instructed in the costs and benefits of the two plans, based on sound economic analyses, so they could make informed decisions.  The County could also offer to new hires only the defined-contribution plan.  The County has already contracted for a study of all benefits, including a defined-contribution plan; however, the study will not be completed until the Fall of 2011 (Appendix D).  Preliminary results will be available in the summer of 2011.

The complete report can be seen by clicking on the attachment.