What happens when a state abandons its defined benefit pension for a riskier, 401(K)-style plan?

  • Taxpayers lose – According to the National Institute on Retirement Security, “for a given level of retirement income, a typical 401(k) plan costs 91% more than a typical pension plan.”
  • Unfunded liabilities increase – closing a pension system exacerbates funding challenges
  • Workers losefew can retire with dignity in a 401(k)-style system

Some states have made the switch and suffered the consequences:

West Virginia
In 1991, the West Virginia Teachers Retirement System (TRS) was closed after decades of underfunding by the state. While teachers contributed 6% of every paycheck to the system, the state failed to live up to its end of the bargain. Instead of paying its share, West Virginia shuttered the system and moved new hires to a 401(k)-style plan. Fourteen years later, with fewer than 18,000 active teachers paying into a fund that supported nearly 27,000 retirees, the funding level sank to 25%. The 401(k) plan also left thousands of teachers grossly unprepared for retirement.

After a thorough evaluation revealed that the pension plan was nearly half the cost of the 401(k) plan, the state reopened the TRS in 2005. When given the option to move back to a pension, 78.6% of teachers made the switch. The plan’s funding level bounced back and today West Virginia’s teachers enjoy an average annual retirement benefit of $18,964.

In 1997, the Michigan State Employees’ Retirement System (MSERS) pension plan was closed and new hires were placed in a 401(k)-style plan. At the time of the plan’s closure, the funded status was 109%. With no new employees paying into the pension fund and an aging demographic, plan costs soared and the funding level dropped; by 2012, the plan was severely underfunded at 60.3%. After 20 years under the 401(k) plan, the state’s Office of Retirement Services found that the median balance in these accounts is just $37,260.

An error made by an actuarial firm resulted in a $2.5 billion unfunded liability for Alaska’s pension systems. The state sued the firm and foolishly used the settlement money to close the pension and switch to a 401(k)-style plan. With the plans closed and no money coming in from new employees, plan costs skyrocketed. The state’s consistent refusal to make the annual required contributions to the pension systems, coupled with an aging demographic, caused unfunded liabilities to double in less than a decade.