Pension Reform News: How to structure an optional defined contribution government plan

In This Issue

Articles, Research and Spotlights 

• How to Structure an Optional Defined Contribution Government Plan
• Texas Needs to Reexamine Law Restricting Firefighter Pension Reform
• Pensions a Large Part of California’s $500 Billion in Government Debt
• Budget Surpluses: A Chance to Reduce Pension Debt

News in Brief
Quotable Quotes on Pension Reform
Data Highlight
Contact the Pension Reform Help Desk

Articles, Research and Spotlights

Best Practices in Optional Defined Contribution Plans for Public Workers

Defined benefit (DB) pensions remain the most common retirement option for public workers. However, growing unfunded liabilities and evolving needs for employment flexibility are prompting governments to consider defined contribution (DC) plans like the private sector’s 401(k). One approach that has proven to be particularly effective for state and local governments is to offer an optional DC plan alongside the traditional DB benefit, giving new hires a choice to select the type of plan that best fits their expected career path. A new policy brief by Reason Foundation’s Zachary Christensen explores this approach, finding that providing employees with this option optimizes retirement for most public workers while also helping governments reduce pension-related debt. The brief provides actionable recommendations for policymakers, such as optimal contribution rates, default settings, and education strategies for new employees.
Policy Brief
Recorded Webinar

A Texas Law Governing Firefighter Pensions Is Straining City Budgets

The Texas Local Fire Fighters Retirement Act (TLFFRA) is the law that sets the rules for the management of city and county firefighter pensions in the Lone Star State. Reason Foundation’s Ryan Frost explains that while the purpose of TLFFRA is to protect the benefits of firefighters, aspects of the law create unreasonable pressures on local governments, tying the hands of policymakers at the expense of taxpayers. The law establishes rules for the makeup of pension governing boards that systematically prioritize the interests of firefighters over the government and taxpayers that will ultimately bear the brunt of any unexpected costs. It also requires the approval of firefighters for any reform to the benefits for new hires, which creates a nearly insurmountable barrier to necessary and prudent adjustments. Texas lawmakers should reexamine TLFFRA to enable essential reforms that balance fiscal responsibility with benefit security.

California’s State and Local Government Debt is Over $500 Billion

California’s combined state and local government debt now exceeds half a trillion dollars, with unfunded pension and healthcare liabilities as the main culprits, reports Reason Foundation’s Mariana Trujillo.  Pension debt alone has multiplied more than sevenfold in the past decade, putting immense pressure on city budgets across the state. Cities like San Bernardino and Scotts Valley are grappling with severe financial strain of increased pension costs, highlighting the urgent need for sustainable pension solutions.

States Should Use Budget Surpluses to Pay Down Public Pension Debt

Newly released fiscal survey reporting from the National Association of State Budget Officers (NASBO) gives a positive outlook for states over the next year. The report projects that many states will see budget surpluses in 2025 due to revenue growth and moderated spending. Reason Foundation’s Steve Vu articulates the opportunity many state governments will have, encouraging lawmakers to dedicate these potential windfalls toward paying down long-standing pension debt rather than using it to pay for new government programs.

News in Brief

Pooling Defined Contribution Plans

A recent issue brief by the American Academy of Actuaries discusses best practices for implementing collective defined contribution (CDC) plans, which feature fixed contribution rates but provide variable retirement benefits, adjusting based on investment outcomes and demographic factors. Unlike defined benefit (DB) plans, CDCs do not promise a specific benefit amount; instead, benefits fluctuate with the plan’s financial health, balancing the need for sustainable income with predictable contributions. Unlike defined contribution (DC) plans, CDCs pool fixed contributions from employees and employers into a single collective fund, allowing for the shared management of investment and longevity risk. This structure mitigates the need for additional contributions if assumptions fall short. Some governmental entities in the Netherlands, Canada, and the United Kingdom have replaced defined benefit plans with CDCs for new hires. However, under current U.S. law, CDC plans are not permitted by the Employee Retirement Income Security Act (ERISA), which generally requires either guaranteed benefits or individual accounts. The full brief is here. 

Pensions Pay Different Fees for the Same Financial Services 

A report from Nasdaq finds that public pension funds pay widely varying fees for identical passive index strategies. Analyzing the S&P 500, Russell 1000, Emerging Markets, and other index strategies, the report reveals significant fee discrepancies. The highest asset size tier (over $1 billion) saw the smallest dispersion in fees, while the lowest asset tier (below $50 million) had the greatest dispersion in fees paid. The report suggests many funds could achieve substantial savings without switching providers by leveraging peer benchmarking data to negotiate better terms. Limited pension investment fee transparency constrains negotiation potential and fiscal savings, but the report suggests using public benchmarking data could enable funds to optimize fees. The full report is here.

Quotable Quotes on Pension Reform 

“I don’t think there’s any question that many of the positions we hire…as well below the private market [in salary. …] We’ve always assumed people stayed in the public sector because of the good benefits, and I think we’re seeing that is deeply eroded.”
— Julie Kushner, Connecticut State Senator and co-chairwoman of the legislature’s Labor and Public Employees Committee, quoted in “CT retirement benefit debate looms large over next term,” Connecticut Mirror, Oct. 30, 2024.

“It’s the cost-of-living adjustment and the 3% compounding that’s driving the pension debt crazy, it’s not the pension itself.”
— Steven Reick, Illinois State Representative, quoted in “Panel discusses proposals to shore up Illinois’ unfunded pension liability,” The Center Square, Oct. 15, 2024.

Reason Foundation in the News

“When you’re making a decision like that—especially when you’re backtracking and you’re undoing a cost-saving reform that was done over a decade ago, you need to keep in mind that that’s going to pack in a lot of risk and that could turn south very quickly with a couple of bad years’ returns.”
— Zachary Christensen, Pension Integrity Project Managing Director testimony before Oklahoma State House Pension Committee, quoted in “Oklahoma pension changes may have been based on myth,” Oklahoma Council of Public Affairs, Nov. 4, 2024. 

“[Oklahoma’s full funding of its public employee pension] is an incredible accomplishment that should be acknowledged and protected. … Any change in the retirement benefit structure could revert or threaten this progress, and this is something that would have a tremendous effect on the fiscal health of this state and, again, the retirement security of your fellow employees.”
— Mariana Trujillo, Pension Integrity Project Policy Analyst testimony before Oklahoma State House Pension Committee, quoted in “Experts warn Oklahoma pension changes could harm state finances,” Oklahoma Council of Public Affairs, Oct. 10, 2024.

Data Highlight

Each month, we feature a pension-related chart or infographic created by our team of analysts. This month, we highlight Steve Vu’s analysis of surveyed state budget surplus funds, also known as “rainy day funds” or RDF. These growing reserves offer states a financial cushion against revenue volatility and economic downturns. As balances grow, states have an opportunity to allocate a portion of these funds toward paying down pension debt compounding at high interest rates, strengthening their long-term fiscal stability. Read the full analysis here.

The post Pension Reform News: How to structure an optional defined contribution government plan appeared first on Reason Foundation.

Source: https://reason.org/pension-newsletter/pension-reform-news-how-to-structure-an-optional-defined-contribution-government-plan/