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Who’s Afraid of a 401(k)?

More and more Connecticut municipalities are moving toward 401(k)-style defined contribution plans, according to data from the Office of Policy and Management.

Between 2012 and 2016, the number of municipal defined contribution plans grew from 76 to 96, while the number of pension plans declined from 215 to 210.

While not a tremendous shift, it does indicate that some municipal leaders – more so than their counterparts in state government – recognize the growing costs of pension plans are becoming unsustainable.

While the vast majority of retirement plans in the private sector are defined contribution plans, the public sector has been slow to catch up, despite the growing specter of debt.

Total pension debt across all 50 states is over $6 trillion, according to a 2017 study by the American Legislative Exchange Commission.

Connecticut has $37 billion in unfunded pension liabilities, according to the state’s valuation, but some organizations like ALEC place the actual unfunded liabilities at over $127 billion when using a risk-free discount rate.

Despite municipal unions agreeing to switch to defined contribution plans, state employee and teacher union leaders have rejected past proposals to move new hires onto defined contribution plans.

Some of the resistance might be political posturing by union leaders who see any change to the traditional “pay, pensions and healthcare” motto as a defeat to unionism as a whole, despite the fact they contributed the problem by agreeing to underfund the pensions in the past.

But there remains a concern far more pressing for the actual employee — namely risk, and whether or not a 401(k)-style plan can provide sufficient retirement income.

“People are scared of retirement,” says Andrew G. Biggs, resident scholar for the American Enterprise Institute. “Even if the amount of money they have is likely to be enough, they’re just scared.”

Biggs says that people who go into public sector employment “tend to be more risk adverse,” than those in the private sector, which is why public-sector employment comes with employment security and benefit protections, typically in exchange for lower wages.

Jack Vanderhei, research director of the Employee Benefits Research Institute, says an employee can “definitely have a decent retirement” with a defined contribution plan.

“One of the distinct advantages of a defined contribution plan is that whatever money goes into that plan is yours, you can’t lose it just because a plan is underfunded,” Vanderhei said.

Vanderhei says public pension plans for state and municipal employees are facing problems due to past funding issues. “It’s still too early to know what the outcome will be in some cases, but it’s obviously a situation where the capacity for the sponsor to fund the necessary amount of money to keep all the promises they made, I think is politically infeasible.”

People are scared of retirement. Even if they’re likely have enough, they’re scared.

Vanderhei notes that public pension plans, unlike private sector pension plans, do not have the federal government to back them up if the sponsor – in Connecticut’s case, the state government – can no longer afford the promises it made in the past.

But there are other kinds of risk associated with retirement plans – investment risk and longevity.

Employees can alleviate investment risk by choosing how their retirement income is invested, choosing less “risky” investments. Longevity, on the other hand, has to do with life expectancy and it can be more tricky to plan ahead. Pension plans pay out for life. In the case of defined contribution plan, a retiree must plan for how much he or she will take from their savings each year in order to meet their needs.

Fear of investment risk caused the Connecticut chapter of the American Association of University Professors to file a grievance in 2010 to allow higher education employees previously enrolled in the state’s only 401(k)-style plan to switch to the state’s pension plan in the wake of the 2008 market crash.

The recession stoked employee fears over losing their retirement savings, but the knee jerk reaction may have cost them in the long-run after the market rebounded significantly.

But Connecticut’s pension plans are invested in the stock market as well. The ups and downs of Wall Street can severely affect Connecticut’s pension plans, driving them further toward insolvency or bolstering the funds with good returns.

The other part of the problem might be a matter of expectations.

Retirement plans are meant to provide a source of income during retirement, but few in the private sector expect to continue to receive the same level of income as they had while they were working.

Vanderhei says most experts believe that 70 to 75 percent of pre-retirement income is necessary to maintain the same standard of living in retirement when factoring in Social Security, reduced costs for going to work and reduced paycheck deductions for benefits. That was the conclusion reached by a commission under President John F. Kennedy in 1962.

“Whether one should have the same standard of living in retirement as they were when they were working is probably as much a philosophical debate as an economic one,” Vanderhei said.

Much of the criticism of 401(k) plans stems from reports showing minimal savings for workers with defined contribution plan. Vanderhei, however, says many of these reports fail to focus on people who have consistently been invested in a plan.

“Where a lot of critics of defined contribution plans attack the experience is that they will look at the savings of employees who have not been eligible for a major portion of their working career or were eligible and they themselves chose not to participate,” Vanderhei said.

EBRI conducts an annual study of 401(k) savings in general and then compares those figures to savings for employees who have consistently participated in retirement plans. The results show those who have consistently participated have on average twice as much in retirement savings.

In general, if you contribute to these plans, if you pay in regularly, you’re going to be okay. It’s really not that hard.

Connecticut’s only defined contribution retirement plan — known as the Alternative Retirement Plan — offers a high employer match of 7 percent, more than double the majority of private defined contribution plans.

But retirement expectations for some Connecticut state employees might be skewed because of Connecticut’s long-standing practice of including overtime pay in pension calculations.

While not applicable to all employees – and certainly not to teachers – workers in overtime-rich agencies like the Department of Correction, the Department of Mental Health and Addiction Services, and the Department of Developmental Services can significantly boost their salaries and in turn boost their pensions.

Massive amounts of overtime can send an employee’s pay from a salary of $57,000 per year, to over $200,000. Historically, pension calculations were based off the employee’s three highest-earning years and included overtime, allowing them pad pensions with overtime.

Union leaders have continually denounced legislative attempts to prohibit overtime from pension calculations, arguing it unfairly harms the worker by not counting all their earnings toward their pension.

The average state employee pension is $34,000 per year, but the figure masks some very high pensions, which top out over $300,000 per year for former university professors and doctors.

State pensioners also receive cost of living increases each year which range between 2 and 7.5 percent, regardless of whether the consumer price index rises.

“The reality is that they’re getting a really, really good deal, and I don’t blame them for not wanting to give it up,” Biggs said. “Nobody wants to give up a sweet deal.”

The most recent Tier IV retirement plan continues to include overtime in pension calculations, but it is averaged out over 5 years and given a cap.

The new tier includes a small defined contribution portion, technically making it a hybrid plan. It is one step closer to a defined contribution plan without actually relieving the state of its continuing pension burden.

The new retirement plan was part of the 2017 SEBAC concessions agreement, which also tied cost of living increases to the CPI for those who retire after 2022.

There appears to be growing recognition that defined contribution plans for state and municipal employees will be the wave of the future, particularly among cash-strapped municipalities and the state of Connecticut, which is trapped in a continual budget deficit.

The Hartford City Council received widespread criticism when it recently brushed off the idea of switching new employees to 401(k)-style retirements after receiving a state bailout.

Everyone acknowledges that reforming Connecticut’s retirement system will save money, but the state is locked into the SEBAC agreement, which maintains the current retirement system until 2027. Pension costs are projected to grow significantly over the next ten years.

What that will mean for state workers and whether the state of Connecticut can actually keep the promises made to those employees is anybody’s guess.

Marc E. Fitch

Marc E. Fitch is the author of several books and novels including Shmexperts: How Power Politics and Ideology are Disguised as Science and Paranormal Nation: Why America Needs Ghosts, UFOs and Bigfoot. Marc was a 2014 Robert Novak Journalism Fellow and his work has appeared in The Federalist, American Thinker, The Skeptical Inquirer, World Net Daily and Real Clear Policy. Marc has a Master of Fine Arts degree from Western Connecticut State University. Marc can be reached at [email protected]

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