This week is National Retirement Security Week! Proclaimed by an official declaration from Congress in 2016, each year supporters of 401(k)-style defined contribution plans use this week to promote their products. We’ve decided to take back retirement security from the salesmen of the financial industry and focus on the most reliable source of retirement security: defined benefit pensions. On Monday, we discussed the true state of retirement security in the United States. On Wednesday, we highlighted how defined contribution plans contribute to the retirement savings crisis. In today’s post, we’ll wrap up by focusing on the strengths of defined benefit pensions.
Defined benefit pensions have long been the gold standard in retirement savings plans. Pensions were first offered in the late nineteenth century. The first public pension plan was established for New York City police officers in 1857. That plan was later expanded to include firefighters. Eventually, a pension plan was created for teachers in Manhattan. During the Progressive Era in the early twentieth century, six states created the first statewide pension plans for teachers and Massachusetts created the first pension plan for general state employees.
Defined benefit pensions are seen as the gold standard because they provide the most secure and reliable path to a dignified retirement. The concept is fairly simple: workers and their employers both contribute to the pension fund during an employee’s career. That money is pooled with contributions from other employees and those combined assets are managed and invested by professionals. Since public pension plans are not tied to the lifespan of any one individual, they can invest for the long term and balance high-risk, high-reward investments with low-risk, low-reward investments. In most public pension plans, investment earnings represent anywhere from two-thirds to three-fourths of revenues for the pension fund.
When a worker participating in a pension plan retires, that worker receives a monthly benefit based on a formula that usually involves three factors: years of service; salary; and a benefit multiplier. This pension benefit is guaranteed for life; a retiree cannot outlive it. Most public employees receive a Social Security benefit in addition to their pensions, but many do not. About 25 percent of all public employees nationwide do not participate in Social Security, but they are highly concentrated in a few states, particularly Alaska, Colorado, Louisiana, Maine, Massachusetts, Nevada, and Ohio. For public employees in these states, their pension may be their only source of retirement income.
Defined benefit pensions also protect individual workers and retirees from the risks of the financial markets. Since public pension plans are pooled, long-term investments, they have time to recover their losses during a recession, whereas individuals often do not. We are seeing this in real time now as pension plans are steadily recovering from their losses during the 2008 financial crisis and the slow, uneven economic recovery that followed. Public pension plans also provide an important countercyclical economic impact during a recession. This is an important fact that is often overlooked so it’s important to highlight it. Pension benefits will continue to be paid, even during a recession. As other sources of economic activity slow down, the spending of pension benefits continues to provide a steady source of economic stimulus. Without pensions, many small towns and rural areas would suffer even worse during a financial downturn.
During National Retirement Security Week, it’s important to remember that pensions provide true retirement security. Pensions have stood the test of time. This is why cities and states are sticking with public pensions.