Reforming Government Pensions to Better Distribute Benefits: What Are the Options
In 2012, there were 19.3 million state and local government workers, with over half of these workers working in education. Most government workers participate in a traditional defined benefit pension plan. Yet, traditional public pension plans provide little retirement security for those who don’t spend a full career in public service. Benefits are awarded (regardless of productivity) according to a worker’s years of service, final average salary, and a benefit multiplier
Workers accrue very little during the first couple of decades in a defined benefit plan, and instead accrue substantial pension wealth in their last years of service as they near normal retirement. For example, in Illinois, a teacher will accrue $28,000 in her first 10 years of teaching, $174,000 after 20 years, $557,000 after 28 years, and then peaks at $1.3 million after 35 years. Pension plans, however, strongly disincentivize work after retirement; an Illinois teacher who works five years beyond 35 years forfeits $49,000 in lifetime pension benefits because every year she chooses to stay beyond retirement is a year she forfeits a yearly pension benefit. Moreover, benefits accrue unevenly, such that a newly hired teacher must remain in a plan for at least 22 years before her future benefits are worth more than her contributions.
In this brief, the Urban Institute evaluates several reform options for state and local pension systems:
- Revising different features in the pension formula, such as lowering the vesting period or boosting the benefit multiplier for employees who work beyond the plan’s retirement.
- Adding a defined contribution component to an existing defined benefit plan.
- Adopting a cash balance plan in place of a traditional plan so that benefits accrue evenly and are not backloaded.
- Using plan contributions to purchase private sector annuities, rather than placing contributions into a public pension plan. Workers would continue to earn interest on annuities until retirement, even if they leave the public sector.
- Extending Social Security coverage to all state and local workers to improve their retirement security.