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Guest Article

Government Employees' Pensions: It's All About Empowerment... But For Whom?

by Joel L. Frank

In the 1960s and '70s, the nation's public institutions of higher education began to acknowledge just how hurtful the traditional defined benefit ("DB") type of pension plan was to their mobile employees. They addressed this portability problem by establishing defined contribution ("DC") pension plans as an option to DB plans.

Case Study in New York

In 1964 the New York State Legislature established an Optional Retirement Program ("ORP") for public employees at the public institutions of higher education. In order to be cost neutral, the employer is required to contribute the same amount to the employee's individual investment account maintained by the DC ORP as would have been contributed on the employee's behalf to the DB pension plan of the Teachers' Retirement System. (This also applied to the employee benefit package for health, disability and life insurance coverage.) The employee is not required to contribute. The employer contributes 12% of the first $16,500 of salary, plus 15% of the salary above $16,500.

Let's assume that an employee who began his or her ORP participation in 1964 has been paid at the same level as a New York City public school teacher during each of the past 36 years. The individual's 2000 account balance would be $1.3 million if all of the contributions were invested in the Guaranteed Interest Fund, $1.7 million if all the contributions were invested in a mix of equities and bonds (the asset allocation employed by the Trustees of the eight DB plans of New York), or $2 million if all of the contributions were invested in the equities fund.

It's True That Each Type of Plan Has Its Advantages

The main advantage of a DB plan is that it assures retiring members with equal periods of service at a given employer a consistent ratio of retirement income to final average salary. And this ratio (though not the amount of retirement income) is predictable if it can be assumed that the employee will stay with a given employer until retirement.

A major advantage of a DC plan is that it adds a consistent and visible percentage of salary to each member's total compensation at the time the compensation is earned. If one person's salary is more than another's, the deferred compensation is greater by the same percentage, not warped out of proportion by age or length of service. This pattern of funding, unlike a DB plan that defers most of the employer's contribution to the final years of long service, helps keep the pension plan a neutral factor when the person is deciding about joining or leaving an employer (also when the employer is making the decision). In an era when increasing numbers of the public workforce are no longer remaining with one governmental agency (federal, state or local) for an entire career, it seems reasonable for each employer along the way to contribute a fair share toward a person's retirement income, and for the individual to have the same ultimate income whether staying with one level of government or moving among the three.

The DC plan also has budgeting advantages for the governmental unit. Pension costs are a constant percentage of salary each year. And the employer's pension obligation for each person is fully and permanently funded at the time the obligation is incurred, not left as an open liability tied to whatever salary levels the future brings.

Employees Should Have a Choice

Recognizing that a DC plan can be designed to provide retirement income at least equal to that of a DB plan, one might ask why haven't the public employee unions fought for their member's right to choose either approach. The answer lies in the word empowerment. The unions want to maintain their influence and control over the employee's life from the moment one first enters the public service until termination, retirement or death, whichever comes first! After all, who receives praise when a state legislature approves enhancements to the DB plan or a COLA for retirees? The unions, of course.

The employee's right to choose the type of plan, DB or DC, which the employee believes would be best for him or herself and their respective families represents a threat to union influence and control. For example, an ORP participant who has the $1.3 million balance is excluded from participating in a COLA program and happily welcomes the exclusion. And why not?! The $1.3 million represents the present value of a lifetime fixed-dollar pension of $138,000 starting at age 65. (Think of this balance as the retiree's Pension Reserve Fund established by the DB plan.) How many public employees in this nation are about to retire, after 36 years of service with one employer, on a pension of half that amount or $69,000, let alone $138,000? And remember, investing the same contribution that the employer would have contributed to the DB plan if the employee chose, in 1964, to remain with the DB Teachers' Retirement System, generated $1.3 million.

Every state should do the right thing, as Florida has just done, and establish an ORP for all of its employees. Current as well as future employees will have the right to choose either the Florida Retirement System's DB plan or the new Florida Retirement System's DC plan, known as the Florida Retirement System Public Employees Optional Retirement Program (FRS PEORP). Current members of the traditional DB plan will be allowed to transfer the present value of their accrued DB pension to their individually owned and directed investment account maintained by the PEORP. This is the largest pension conversion of its kind in the nation's history. The sun, indeed, shines in the Sunshine State.

Just think about the number of employees at the nation's public institutions of higher education who opted out of DB plans in the 1960s-'70s. Close your eyes... just look at their contented faces. The word empowered is clearly visible. The nation's public employees, like their colleagues at the public institutions of higher education, should have the statutory right to accumulate wealth, if they so choose, through their employment-based pension plan. Annuitization of pension wealth should be voluntary not compulsory. After all, the state capitols and city halls do not issue stock options.

Joel L. Frank
PO Box 148
Marlboro, New Jersey 07746-0148
(732) 536-9472

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