We all know that pensions provide a safe and secure retirement for public employees in a cost-effective way. In many states, though, anti-pension ideologues and politicians try to sell pension “reform” as a way to save money for the state. However, the example of states that have actually switched from a defined benefit pension plan to a defined contribution (401k-style) system shows that these “reforms” are simply snake oil sold by hucksters. Alaska, Michigan, and West Virginia demonstrate the failure of switching from traditional pensions to a defined contribution system to provide retirement security for public employees.
Recently, the National Institute on Retirement Security released a report in which they examined the consequences for these three states. Their report found that costs for the defined benefit plan exploded after it was closed and new employees were moved to a defined contribution system. The reason is simple: without new employees paying into the plan, the pension was not receiving enough of the required contributions to cover its payouts. Pension plans work because current workers are paying into the plan while retired workers are receiving their monthly payments. Without the inflow of new workers, the cash flow for the plan dried up. After Michigan abandoned its pension, the funding status of the pension plan went from 110% to 60%.
Furthermore, the workers forced into the defined contribution system discovered that their retirement was much less secure than it would have been in the pension. 401(k)-style defined contribution accounts consistently provide lower retirement benefits than defined benefit pensions do. In fact, the retirement security crisis for teachers in West Virginia became so severe that the state reopened the pension plan and its funding stabilized with new employees paying into the system. The lesson for other states is clear: closing a pension plan and moving employees into a defined contribution system is a recipe for disaster.