We all know that many state retirement plans (defined benefit plans) or pensions are in trouble. We all know that many workers who have access to a defined contribution plan such as a 401(k) underutilize or simply do not participate. So what do you get when you combine the two? The smoke and mirrors effect of fixing a problem that was never really your problem in the first place.
That’s beside the point. The problems exists nonetheless and the solutions these trouble plans are coming up with may or may not be the answer we want to hear. Let’s talk about the defined benefit plan or pension. Most states have set up an unsustainable contribution to their plans of 4%. This seems like a hefty amount of money set aside for workers hired to provode the services a state desperately needs.
Because the pensions of these states relied on the stock market to sustain those contribution levels, any hiccup in the markets turned around and shook these plans, sending most into what may have looked like actuarial death spirals. The same happened for most of the citizens in the US but with the restrictive nature of budget balancing, this became a huge burden on state coffers.
So taxpayers took up the complaint to rein in the costs of these programs, in large part, as many around the country agree, pain is best when shared.
Now a defined contribution plan relies on your ability to put a portion of your paycheck away – pre-tax- direct that money to the investment of your choice and hope that your employer makes good on their promise to contribute something, anything as an incentive to help you invest even more.
So what do you get when you put both plans together? According to the actuaries who are basically the folks who project into the future how much a pension plan is liable for, you get a hybrid they can love.
Consider Utah, where the state once contributed 16% of their workers income to their retirement plan. This was an untenable amount that needed to be reduced. Realizing that they do have some sort of obligation to these workers, the plan was amended to include a 401(k) plan with the state’s pension contribution reduced to a cap of 10%.
According to a recent Wall Street Journal article, states are doing what they can but the employees are not exactly thrilled. In Michigan, where 130,000 workers in education are covered by a pension, “new school employees as of July 1 contribute 2% of monthly income to a 401(k)-type fund, with state employers matching up to 1% of pay. Employees are automatically enrolled in the fund but can choose to opt out or choose to contribute more.” according to the story.
So far, even though other states are looking at the change, the effort is dragging with many state lawmakers. Yet the problem persists – as the markets continue to try and find their footing. The success the average investor without a pension has had pales to the potential retirement income a pension provides. The participation of employees in the private sector with their 401(k)s, the mistakes they have made (borrowing or cashing out these plans in times if financial difficulty) does not make this an attractive alternative. The combination of both plans may be worth considering but it opens the door to more changes in the pension to a more self-directed plan. And that is what is most worrisome.
Read the WSJ article here.
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