New Pension Plan Could Increase Taxpayer Costs and Cut Benefits Deeply
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HARRISBURG, PA (October 1, 2013) – The Keystone Research Center today urged careful scrutiny of Representative Glen Grell’s pension package, unveiled yesterday, warning in particular that a “cash balance” pension plan for new employees could increase taxpayer costs while deeply cutting benefits for most teachers, nurses, and other public employees.
“Some elements of Representative Grell’s proposal build sensibly on pension reforms enacted in 2010, and his plan also recognizes that a shift to a 401(k)-type pension plan is not the way to go” said Dr. Stephen Herzenberg, economist and executive director of the Keystone Research Center. “His proposal to use bonds to pay down the state’s unfunded liability and his voluntary approach to achieving pension savings from current employees deserve careful examination.”
Dr. Herzenberg voiced concern, however, about Representative Grell’s proposal to put new employees into an unfamiliar type of pension known as a “cash balance” plan, which eliminates guaranteed pensions tied to years of service.
“This little-vetted retirement option could dig a deeper pension hole for taxpayers, while leading to an exodus from public service among experienced mid-career employees who hold our schools and state agencies together,” he said. Dr. Herzenberg encouraged policymakers and the public not to jump to conclusions about cash balance as the solution without looking carefully at its impact on public employees, taxpayers, and the quality of public services.
Dr. Herzenberg’s comments accompanied the release of a new KRC pension primer that explains cash balance plans and examines their potential impacts on taxpayers and retirement security in Pennsylvania.
Instead of receiving a guaranteed benefit tied to years of service, employees in cash balance plans receive a guaranteed interest rate on contributions made by the employee and employer to individual accounts. Upon retirement, the “cash balance” of an employee’s account can be converted into a fixed annual pension payment or “annuity.”
The Grell cash balance proposal would require 7% employee contributions and 4% or 5% (the higher percentage for employees with 15 or more years of service) employer contributions, while guaranteeing employees a 4% return on investment plus half of all pension plan returns above 4%.
The KRC brief finds that:
- Long-term, cash balance plans could erode the investment returns on pension plan assets below the current projected 7.5%, increasing the state’s unfunded liabilities. A lower return if pension fund managers treat the minimum guarantee to workers as their rate-of-return target (rather than the current 7.5%) and thus invest in more conservative ways.
- The proposed cash balance plan would result in substantial reductions in the pension benefits of public employees. Building on actuarial studies of two similar cash balance proposals advanced in the 2011-12 legislative session, KRC estimates that Representative Grell’s cash balance proposal would reduce average benefits by roughly 20% on average across a range of career trajectories.
- The proposed cash balance plan could make it more difficult for state agencies and schools to retain experienced employees because it would reduce pensions for long-term career employees by an estimated 46% to 66%. This could lead to turnover that erodes the quality of public service and also make it necessary to provide offsetting wage increases, another cost for taxpayers.
- In effect, the proposal would result in future public employees paying for almost all of their pension benefits.
“Cash balance plans are poorly understood and have not gotten the scrutiny that led the Legislature to wisely reject 401(k)-type individual accounts,” said Dr. Herzenberg. “Rather than rush to approve a radical pension overhaul, lawmakers should stick to the elements of Representative Grell’s plan that build on the progress already made on pensions in 2010.”
The Keystone Research Center’s new brief is the eighth in a series.