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Finance & Taxation        < Previous        Next >


Pension Reform


Q. I've heard that the school districts in our country face a gigantic shortfall in their pension funding. What's to be done?


According to the American Legislative Exchange Council, school districts should change the way they structure their pension plans, or we will be buried by ever-increasing requirements to keep pensions funded. They recommend changing from "defined benefit" pension plans to "defined contribution" plans.


Traditional pension plans with a defined payout ("defined benefit plans") are good only for government workers who spend 20-30 years with the same employer. At the point of retirement, the pension benefit is calculated in large part by using the average salary from the previous two or three years' work, or by using the average salary from two or three years in which salary was highest. That makes the maximum payout possible only to employees who earn substantial income. In government service, senior employees have the highest salaries.


Self-directed retirement investment plans ("defined contribution plans") benefit both senior government workers and younger employees. Defined contribution plans are similar to 401(k) plans widely available in the private sector. They are portable between jobs and career choices - as they are often administered by a private, unaffiliated entity - and investment earnings can be consolidated into an IRA or similar account should the worker choose to leave public service.


There are no limits to the benefits an employee may earn in a defined contribution plan. This is especially beneficial to government employees who remain their employer less than 5 years - nationally, roughly 40 percent of defined benefit plans require more than 5 years of service before and employee is vested. With self-directed investing responsible for retirement earnings, the individual controls how much or how little risk he or she is willing to take on. Therefore, his or her earnings at retirement will reflect personal choices rather than choices made by plan administrators.


Defined contribution plans benefit taxpayers as well. The potential for unfunded future liability looms with a defined benefit plan. If plan administrators make poor choices, are influenced by political or social whims, or if the general marketplace declines, and returns on investments are less than promised in the defined benefit, taxpayers are stuck with the bill. On the other hand, defined contribution plans are fully funded from the very beginning.


Defined contribution plans are a valuable recruiting tool for government agencies - and an incentive for young workers to enter public service. Short, or in some cases, immediate vesting schedules, and portable retirement benefits are why defined contribution plans are attractive to younger employees.



Homework: Here are some good articles on pension reform from a Michigan think tank:



By Susan Darst Williams Finance & Taxation 09 2008




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