Some experts question whether moving public employees, future teachers to 401(k) plans would save the state money, warn about effect on ability to recruit workers
Courier Journal, Louisville, Sept. 15, 2017
Kentucky pension crisis: Are 401(k) plans the solution?
By Tom Loftus
To the taxpayer, the solution to Kentucky’s pension crisis may seem simple: Just move those public employees from pensions to a 401(k).
Indeed, Kentucky’s pension consultant — PFM Group — recommended that very thing when it released a report in August calling for moving state and local government employees in non-hazardous jobs to a 401(k)-type benefit plan — as well as teachers hired in the future.
The move, PFM says, would stabilize costs and significantly reduce the state’s risks — particularly the risk that pension plan investments will not perform as expected. Reducing risk, PFM said, is a "particularly critical" goal given the severe funding shortages in a pension system that's saddled with debts of at least $40 billion by official estimates but that the Bevin administration says actually exceed $64 billion.
“It alleviates a lot of the risk now borne by taxpayers who fund the retirement plans,” Sen. Chris McDaniel, a Taylor Mill Republican who heads the Senate budget committee, said of the 401(k) proposal. McDaniel said it is “also a matter of fairness” to taxpayers, many of whom have their retirement savings in a 401(k).
But some experts say that such a move may damage the retirement security of public employees and reduce the ability of state and local governments to attract and retain good workers — with little or no savings for the state.
“I’m hoping public pension reform is not the kind of easy solution of, ‘Oh, the private sector does it, why don’t we?’ ” said J.P. Aubry, associate director of state and local research at the Center for Retirement Research at Boston College. “We want to encourage retirement security, and the current model for retirement in the private sector has made retirement more precarious.”
Keith Brainard, research director for the National Association of State Retirement Administrators, said risk doesn't disappear under a 401(k) plan.
"These proposals shift that risk from the state and its public employers and taxpayers and put it all on the workers. In fact, there’s going to be more risk because they are no longer in a group that can manage the risk much better," he said.
Whether the moves actually will save the state money is a question being hotly debated.
Jason Bailey, executive director of the Kentucky Center for Economic Policy, of Berea, said, “Moving employees into 401(k)-type plans is actually more expensive … and harms retirees while making it much more difficult to attract and retain a skilled workforce.”
Not so, says Bevin administration Budget Director John Chilton.
“The narrative that it costs more to enroll new employees and new teachers in a defined contribution retirement plan is false. The truth is, switching doesn’t cost any more taxpayer dollars,” Chilton said in a short statement. “The PFM report shows it will also provide a generous retirement benefit for future teachers and state workers.”
The strong endorsements of Chilton and McDaniel indicate the shift to 401(k)-type plans may well be part of the package of changes lawmakers will consider this fall at a special legislative session that Gov. Matt Bevin has promised to call.
Pensions vs. 401(k)s
Kentucky offers a traditional pension, or “defined benefit” plan, to most of its employees and teachers. In these plans, the employee and employer contribute to a retirement fund. On retirement, the employee is paid a monthly benefit check for the rest of his or her life. The amount of the check depends on how many years the employee worked, the employee’s salary and other rules of the pension plan.
The benefit is stable, and any risk of a downturn in investments held by the pension plan is borne by the plan.
Under a 401(k)-style plan, also known as a “defined contribution” plan, the employee decides how much to allot toward retirement savings and the employer matches these contributions up to a certain level. The employee decides how to invest the money. Benefits paid upon retirement depend on how much the employee is able to accumulate in the retirement account.
And any risk of a downturn in investment markets is borne by the employee.
What could change look like?
PFM recommends that future state and local government employees in non-hazardous jobs be put in a 401(k)-style plan. It also recommends that current state and local workers in non-hazardous jobs have their accrued benefits frozen, with future pension benefits part of such a 401(k) plan. Employees would be offered a buyout for the value of the benefits they’ve accrued, with the equivalent cash value being rolled into a new 401(k) account.
These recommendations do not apply to police and firefighters and others currently covered in the state hazardous duty plans.
And PFM recommends any teachers hired in the future also be put in a 401(k)-style plan while also being given Social Security benefits. (Teachers, unlike most public employees, currently do not get Social Security. Their pension plans are designed to require higher contributions by teachers and their employers and to pay a higher benefit sufficient to also replace Social Security.)
PFM suggests a plan where an employee would be required to contribute 3 percent of salary and the government employer would be required to contribute 2 percent of salary. The government employer would match 50 percent of additional employee contributions up to 6 percent of salary. So, for an employee contributing 9 percent of salary, the employer would contribute 5 percent for a total of 14 percent of salary.
PFM said these recommendations “should provide career state and local employees and teachers a sufficient and sustainable benefit for a dignified retirement through a combination of benefits from (their state plans), Social Security, and personal savings.”
Jim Carroll, president of the advocacy group Kentucky Government Retirees, said the immediate problem with the recommendations is that moving current employees into 401(k)-like plans violates an “inviolable contract” in state law that he says protects the benefits promised to state and local employees when they were hired.
Aubry, of the Center for Retirement Research, said reducing risk to the state is important, though he said it will do little if anything to reduce the current large debt. And he warns that there are “serious potential issues with retirement security” under the design of most current defined contribution plans.
“The biggest concern is that employees and employers very often do not contribute enough” to a 401(k) plan, Aubry said.
He said the average balance for people age 55 to 64 in a 401(k) or individual retirement account is $111,000. “That’s far less than needed for a secure retirement,” he said.
Brainard, of the National Association of State Retirement Administrators, said only three states (Alaska, Michigan, Oklahoma) and the District of Columbia use a 401(k)- style approach as their only or primary benefit plan, though several others offer optional or supplemental employee savings plans.
Brainard said in designing a 401(k)-type plan, Kentucky policy makers need to keep in mind one principle.
“There are reasons for providing a retirement benefit and they all really revolve around the ability of the state and its political subdivisions to attract and retain the talent that it needs,” Brainard said. “... One risk that needs to be considered is the risk that services will not be able to be delivered in a cost-effective and timely manner.”
But McDaniel notes that participation in the 401(k)-type plans would be mandatory, and workers in control of their savings and investments can assure a secure retirement under the recommended plan by making "prudent decisions."
Moving future teachers
PFM acknowledges in its report that its recommendation to move future teachers into a new 401(k)-type plan would cost more. That’s because teachers do not get Social Security — and moving future teachers into a new plan combining a 401(k)-type benefit with Social Security would require the government picking up the added cost of paying for Social Security.
PFM suggests that this cost — 6.2 percent of a teacher’s salary — could be shifted from the state to the local school board.
Brent McKim, president of the Jefferson County Teachers Association, called that “a terrible and expensive proposal.”
“I keep hearing, ‘We can’t afford the risk. We can’t afford the risk,’ " McKim said. "But there are other strategies to share risk rather than this recommendation" that drives costs for the state.
But Sean McNeeley, of PFM, said in an email that by eliminating risks — including the risk that the Teachers’ Retirement System will not meet investment assumptions — the move means the system liabilities will no longer jump unexpectedly and require additional contributions from the state.
Save money, or cost more?
McNeeley said the recommendations on shifting to 401(k)-style plans would lead to reduced spending for each plan in the short and long term.
He pointed to tables in PFM's recent report that show the recommendations would save $123.8 million in 2018-19 — savings that would grow to $212 million in 2028-29.
But Bailey, of the Kentucky Center for Economic Policy, said his study of the PFM report does not show how the consultant arrives at those savings, or whether they account for additional costs such as the cost for either the state or local school boards to cover Social Security payments for new teachers.
Last month Bailey and groups representing public workers released a report concluding that the move to 401(k)s would cost more. That's because shutting down existing plans that still must pay off accumulated liabilities would no longer have new employees joining them.
"The added cost comes from the closed plan no longer being balanced by workers of different ages, which means it must take on a more conservative investment portfolio that will earn lower returns," Bailey said.
Bailey emphasizes that pension reforms of 2013 already put new hires into a hybrid plan that combines features of a traditional pension and a 401(k). The state and local government costs for new workers under this plan is already very low.
Bailey said his analysis of the PFM report and Kentucky Retirement System's data shows the government's costs would be slightly higher under the proposed 401(k) approach for future hires.