A Cautionary Tale for Public Pension Plans Considering a Move to DC

Maintaining the Defined Benefit (DB) plan can be the most cost effective option for public pension plans in the long run despite funding shortfalls. Because of their uphill battle to close funding gaps, many consider moving employees to a Defined Contribution (DC) plan. However, this might not be the most beneficial to the plan sponsor.

I read a recent study, “Enduring Challenges: Examining the Experiences of States that Closed Pension Plans," by the National Institute on Retirement Security (NIRS) that suggests otherwise, supporting our view on the subject here at SEI. NRIS has also made available a webinar recording on its research.

Ignites recently recapped that study, reviewing case studies of six different state retirement systems’ changes to their retirement plans, how it impacted funding and the overall financial health of the plan.

The researchers found that funding challenges don’t go away by changing or reducing retirement benefits for future employees. Closing the DB plan does not erase or lower the funding gap, and the new DC benefits costs are likely to be of similar annual cost to the eliminated DB benefits. In addition, when DB plans are closed, fewer employees are paying into the plan, contributing to the shortfall. And who makes up the difference? Often, state taxpayers.

The Ignites article, “Switching to DC Plans Not a Solution for Pension Funding Gaps: Report,” explains: "Four states that have closed their pension plans to new hires in recent years found the move to defined contribution or other plans actually increased pension costs while leaving employees less ready for retirement, according to research published by the National Institute on Retirement Security."

Ignites also looked at alternative plans that some employers are exploring to deliver retirement funding to their employees, such as hybrid plans or collective defined plans. 

(Login Required)