If you want a good history lesson, look no further than the Rust Belt. Beyond the relics of America’s industries are hardworking Americans serving as living reminders of the devastating consequences of what happens when cities and states close a public pension plan. In West Virginia and Michigan in particular, you’ll find two narratives about why pensions matter, especially in today’s economy.
As with any good history lesson, it’s always good to start at the beginning, where more than one hundred years ago some states and local governments began offering pensions to their teachers, firefighters and other public employees. Public pensions play several important roles for these public employees, government employers and taxpayers.
The 401(k) was created by a provision of the Revenue Act of 1978 as a vehicle to give additional tax-advantaged savings to highly paid executives. At first, it was a little noticed provision outside of the C-suite. In the early 1980s, however, the Reagan administration changed the regulatory interpretation of that provision and allowed much more widespread use of the 401(k). Combined with other laws passed during the Reagan administration that increased the regulatory burden on private-sector pension plans, private companies began shifting away from traditional pensions to 401(k)s. Most cities and states have not followed this trend; however, there are a few exceptions.
In the 1990s, both West Virginia and Michigan closed public pension plans. West Virginia was first, closing its teacher pension plan in 1991. All new teachers were placed in a 401(k)-style defined contribution plan. In 1997, Michigan closed its traditional pension plan for state government employees. What happened next is a warning to other states or cities considering a similar course.
After closing the pension plan, two things happened in both states: the cost of the plan increased dramatically and retirement security for employees plummeted. As plan costs skyrocketed in West Virginia, the state began studying its options.
In 2003, West Virginia found that providing a pension to teachers cost taxpayers half the amount of a comparable 401(k)-style plan. After 15 years, West Virginia reopened the pension plan for new teachers and gave teachers in the 401(k) plan an option to switch into the pension plan. Over 78 percent of teachers switched to the pension plan.
Michigan, too, has seen plan costs increase and funding levels decrease. But worst of all, Michigan is forcing its state employees to retire into poverty rather than providing a modest, reliable defined benefit. This year marked twenty years since Michigan closed its pension plan in favor of a 401(k). In January, the state Office of Retirement Services reported that the median account balance of employees in the 401(k) plan is just over $37,000. The average balance is slightly higher at $77,000. A lifetime annuity would give a Michigan social service worker retiring at age 65 just $400 per month in retirement income.
Recently our organization, the National Public Pension Coalition, released a report titled “Why Pensions Matter.” In recounting the history of defined benefit pensions in the private sector and in states like West Virginia and Michigan, the report finds that traditional pensions offer a superior retirement for working families. Cities and states began offering public pensions not just to provide retirement security for their employees, but also so they could recruit and retain quality employees. As the private sector moved away from traditional pensions, inequality in retirement wealth grew.
The experiences of West Virginia and Michigan demonstrate that the same thing happens in the public sector. For both taxpayers and public employees and retirees, pensions matter.