Governments Should Adopt Alternative Plan Designs

The Facts

  • Alternative plan designs provide workers with greater flexibility to save for a secure retirement.
  • Such plans are easier for governments to manage.

Defined Contribution and Cash Balance plans provide workers with a path to a secure retirement

In an effort to improve retirement plan transparency and accountability, some state and local leaders have adopted alternative plan designs that are less complex and easier to manage than the traditional Defined Benefit structure. These plans tie benefits more closely to contributions and investment returns, which helps to ensure that governments have enough funding to cover their promises and also provides workers with greater flexibility to save for a secure retirement regardless of where their career paths take them. Two examples of alternative plan designs are Defined Contribution systems and Cash Balance systems. Both Defined Contribution and Cash Balance plans offer portable benefits that can be tailored to include important protections for workers, such as adequate savings rates; short vesting periods; professionally managed, low-fee investment options; and annuity payments upon retirement.

Defined Contribution plans put workers in control

Defined Contribution plans, such as private-sector 401(k)s, provide workers with benefits that are based on the value of their accumulated contributions and investment earnings. Under a Defined Contribution plan, workers and their employers contribute a fixed dollar amount or a percentage of the individual’s salary to a retirement savings account each year. The savings are then invested in funds that are selected either by the employee or the employer.

Most private employers offer retirement benefits through Defined Contribution plans. These systems provide workers with more control over their retirement savings and greater flexibility throughout their careers by allowing them to roll over their retirement savings, including contributions made by their employers, into plans offered at their new jobs or by independent providers. Furthermore, one of the most significant benefits of Defined Contribution plans is that they permit workers to earn adequate retirement savings throughout their career. This is in sharp contrast to other plans that only allow for limited savings opportunities until the final years of a person’s career. Defined Contribution plans do not include back-loaded formulas used by other plans to weigh factorssuch as years-of-service with a particular employer and final salaryto calculate workers’ benefits. This is important because it means that workers who change jobs or move to a new city or state before reaching retirement eligibility still have a clear path to a secure retirement.

Defined Contribution plans are also easier for governments to manage since benefits are tied to contributions and investment returns, rather than complicated projections. As such, governments cannot accumulate pension debt, which ensures that the systems remain sustainable and that unpaid benefit costs do not threaten the fiscal health of communities. Research has shown that Defined Contribution plans are equally as cost-effective for governments as traditional Defined Benefit plans and achieve similar investment returns.

One example of a well-managed public Defined Contribution plan is the Federal Thrift Savings Plan, which covers federal workers as well as service men and women in the United States Army, Navy, and Coast Guard, and other uniformed service personnel. The plan features a number of protections for members, such as automatic payroll deductions, professionally managed, low-fee investment options, and withdrawal options that include monthly annuity payments. The states of Michigan and Alaska, along with a handful of cities, also offer retirement benefits under Defined Contribution plans.

Cash Balance plans protect retirees and governments

Cash Balance plans incorporate elements of both 401(k)-style Defined Contribution systems and traditional Defined Benefit systems. Under a Cash Balance plan, workers and employers contribute a fixed dollar amount or a fixed salary percentage to a retirement savings account each year, and governments guarantee a certain investment return on those contributions. Benefits are paid out as lifetime annuities, ensuring that retirees are provided with a consistent monthly income long after they stop working.

Unlike back-loaded traditional Defined Benefit plans, which provide workers with generous benefits only if they spend their entire career in the same pension system, workers who are enrolled in Cash Balance plans earn retirement benefits evenly over the course of their careers. Therefore, individuals who are enrolled in these plans are able to work for local governments or school districts for part of their career without undermining their retirement security. Cash Balance plans also end an unfair practice that penalizes public workers who change jobs or move to different states.

In addition, Cash Balance plans include important protections for governments. Benefits are tied to contributions and investment earnings—making the cost of providing retirement benefits more predictable—and governments share an appropriate amount of risk with plan members. This allows governments to better estimate plan costs for short- and long-term budgeting purposes. Governments also have the ability to make adjustments if economic conditions change and still maintain important protections for workers. Several states, including Texas, California, Kansas, Kentucky, and Nebraska, have already enrolled all or a portion of public workers in Cash Balance plans.