Defined-benefit vs. defined-contribution retirement plans:
Defined-benefit plans are known as pensions. Employees receive a set monthly amount upon retirement, guaranteed for life. The monthly benefit is based upon the participant’s wages and length of service.
Defined-contribution plans are sometimes called 401(k)-style plans, for the section of the tax code that enables them. Other defined-contribution plans include 457 and 403(b) plans. In these plans, the employee saves money, often matched by the employer, and the ultimate benefit is based on how much is saved and the investment earnings with no guarantee of ongoing benefits.
The private sector moved away from pensions for a variety of reasons. The shift began with the adoption of the Employee Retirement Income Security Act of 1974, which set stringent standards for private pensions to protect workers. Then the law enabling 401(k) retirement plans went into effect in 1980, enabling workers — who change jobs an average of every 5 years — to take benefits with them.
Pension plans have persisted in government because the institutions are enduring, and because the workforce is older and more risk averse, less mobile and more unionized, according to the Center for Retirement Research at Boston College. Defined-benefit plans can be cost-efficient. The cost to deliver the same level of retirement income to a group of employees is 46 percent lower in a defined-benefit plan than a defined-contribution plan, according to the National Institute on Retirement Security.
Most of Washington’s 13 public retirement plans are traditional pension plans, but the system also offers hybrid retirement plans to state and local government employees. In these plans, the employee sets aside money for the defined-contribution component, and the employer contributes to a pension calculated at 1 percent per year of service.
State Sen. Joe Zarelli, R-Ridgefield, would like to go further by switching completely to a defined-contribution system for state and local public retirements. His proposal would:
• apply to new employees;
• require employees to contribute 5 percent of their salaries to the plan until 35, 7.5 percent after that, and employees older than 55 could save as much as 10 percent;
• include an employer match up to 6 percent;
• let employees choose to take their benefits as annuities; and
• include plans for life insurance and long-term disability.
Don Bivins became a firefighter 35 years ago to save lives. At age 19, he gave little thought to his retirement.
Now, at a time when many of his private-sector peers have seen their own retirement dreams dashed, and with the state facing a two-year $4.6 billion shortfall, Bivins’ pension and those of his fellow government workers are drawing new scrutiny. A fight over public pensions may be looming in the legislative session that begins Monday.
But the attention on public pensions reveals as much about the benefits that private-sector workers have lost over the past three decades as it does about the perks that public employees still receive.
Since retiring from his job as Vancouver’s fire chief at the start of the year, Bivins, 54, is drawing annual retirement benefits of $94,000, equivalent to 70 percent of his final pay. He’s collecting on a promise the state made when he first went to work: In exchange for a long career, he could count on a steady income later in life.
It once was common for businesses to make similar guarantees, but things began changing in the 1970s (see box below). In 1980, 38 percent of private-sector workers in the United States had a pension plan that provided steady, if small, retirement checks until death. Today, only 15 percent of private workers still have pensions. The rise of the 401(k) plan has eroded the financial guarantees that were once available to a wide swath of the middle class, and have put the burden for saving enough — and investing well — on workers.
Under these defined-contribution plans, workers invest a percentage of their paycheck, often matched by their employer, typically in mutual funds. How much they save and how their investments fare determine how much they will have for retirement.
The outlook is poor for many Americans. The average 50-something has saved just $29,000 for retirement, which would amount to about $190 a month, according to Wells Fargo’s annual retirement survey.
Compare that to Bivins, who can count on benefits that will total $1 million before his peers start collecting Social Security at age 65, as critics have recently pointed out.
Because of his long service and relatively high salary, Bivins’ pension is higher than most in Washington’s retirement system, which covers teachers, police officers, firefighters, and other local and state government workers. As Vancouver’s fire chief, he managed 205 employees and a $31 million annual budget.
State pensions — typically 2 percent of pay multiplied by the years worked — pay out an average benefit of $18,676 a year.
“Pensions aren’t about getting rich,” said Mark Johnston, president of the Vancouver Fire Fighters’ Union. “They are about having a decent, stable source of income so people can live a dignified life into retirement.”
That’s a guarantee that eludes many workers outside government, who lost net worth in the stock and housing markets crashes. A 60-something worker who put in more than 30 years on the job had an average 401(k) balance of $198,993 in 2009, according national figures compiled by the Employee Benefit Research Institute. That would yield an annual income of $12,668 for a 65-year-old woman if she put it all into an annuity that would expire upon her death, according to a calculation prepared by Dan Foster, a certified financial planner and public accountant with Foster & Associates in Vancouver.
Public workers “have a real Cadillac program,” said Lee Hemen, a local pastor and government critic. The 57-year-old doesn’t have a pension, but will rely on his own retirement savings. “I’ve maintained (those savings) and gained a little bit. But I have a lot of friends, they have lost a lot and they don’t know what they’re going to do.” He’s bitter that he and his friends will underwrite the sort of benefit they won’t enjoy.
The private sector pays about 92 cents per hour worked toward employee retirement plans, while state and local governments nationwide pay $3.04 an hour, according to the Employee Benefit Research Institute. That’s in large part reflective of the unique make-up of the government work force, which is highly educated and specialized, the institute points out. The private sector includes educated and specialized workers, too, but businesses employ the bulk of low-paid, low-skilled workers, and their minimal benefits lower the average for all nongovernment workers. A firefighter might be classified as a service worker, but the job is a far cry from flipping burgers.
Public retirement benefits are on par with those at the biggest companies, the ones with which government is likely to compete for workers, several experts said. Among Clark County’s six largest private employers, three offer 401(k) plans. Safeway and SEH America offer pensions, but would not discuss the benefits they provide.
Legacy Health System, a nonprofit that employs about 900 workers in Clark County, provides both a 401(k)-style plan with an employee match and a cash-balance pension. Legacy contributes 3 percent to 7 percent of an employee’s annual pay to his or her pension, depending on the worker’s length of service. When employees leave Legacy, they can take that as a lump sum or an annuity.
Legacy designed its retirement benefits to be both competitive and financially sustainable, spokesman Brian Willoughby said. “We want to attract and keep good employees and honor what’s been promised,” he said. “In tough economies, that’s a real balancing act.”
With 10,000 baby boomers across the country turning 65 each day, that balancing act is likely to stay at the forefront for both public and private employers. It’s certainly an equation that worries state Sen. Joe Zarelli, R-Ridgefield.
He believes current public pension benefits are not financially sustainable in the long term, even if Washington’s pension programs are currently in good shape. He wants the state to shift to a defined-contribution program similar to what prevails in the private sector.
Under Washington’s current defined-benefit approach, the employer — essentially the taxpayer — and the worker both put money into the state pension fund. The state’s investment board has averaged 8 percent annually over the past 20 years, a rate of return that few individual investors could achieve. About 75 cents of every dollar a state pensioner ultimately receives comes from those investment earnings.
The Pew Research Foundation recently ranked Washington fourth in the country for the financial health of its pension programs, nine of which are open and accepting new employees. But Zarelli sees trouble ahead. About 473,000 current, past and retired state and local government employees are guaranteed checks throughout retirement until death, even if the pension funds run low. And he believes the funds are likely to tap out, given that the Legislature has historically set contribution rates for employers and workers lower than the state actuary recommends.
“In the last 10 years we have not made a full payment” into state pension funds, Zarelli said. “You have the perfect storm of volatile returns affecting the system, and the state doesn’t make its full contributions. The value lost of money and time not invested creates a problem.”
Two state pension programs have only enough money to cover 72 percent of their future obligations, according to a report by state Treasurer James L. McIntire. These underfunded programs are closed to new members, and cover state and local government workers who started before 1977.
The trouble may spread to the plans that are currently healthy if the Legislature continues to lowball contribution rates. Government paid as little as 1 percent of salaries into the pension funds for teachers and office workers who started after 1977, less than the state actuary recommended.
According to the actuary’s calculations, which take into account life expectancy and projected investment returns, state and local governments need to pay 11.09 percent of salaries for the office workers’ retirement plans in 2013, and 16.1 percent for the teachers’ plans in 2014. Compare that to the 3 percent match that private-sector employers typically offer on a 401(k) plan.
Pension fund contributions don’t just pinch the state budget. They apply to most local public entities, such as school districts, cities and counties. The city of Vancouver paid $2.91 million of its $319 million budget toward pension contributions for office workers in 2009, a figure that’s expected to rise to $5.01 million in 2016.
This Legislative session, Zarelli intends to bring forward his proposal to shift to a defined-contribution approach for state workers. The state would match employee contributions up to 6 percent. Instead of putting the state at financial risk by guaranteeing fixed payments for life, the plan would include other financial tools like annuities and life insurance options to create a program that feels like a pension.
Sen. Craig Pridemore, D-Vancouver, former chairman of the state’s Select Committee on Pension Policy, questions Zarelli’s proposal.
If there’s a problem, Pridemore said, it’s that the Legislature hasn’t had the political will to set pension contribution rates according to the state actuary’s recommendation.
“It seems to me (Zarelli) is trying to fix a problem that doesn’t exist,” he said. “The current retirement programs are fully funded.”
Steven Hill, the director of the state Department of Retirement Systems, credits Zarelli with making a very thoughtful proposal, but said although it might save money in the long run, it would cost more than the status quo at first.
“In this environment, you’re not going to get anywhere with a proposal that’s going to cost more,” Hill said
Instead, at Gov. Chris Gregoire’s direction, Hill is encouraging new public employees to opt for the hybrid retirement plans the state first offered in the late 1990s. These plans provide a pension calculated at 1 percent of annual pay multiplied by years of service, combined with a 401(k)-style savings plan. While 35 percent of public employees work long enough to benefit from a traditional pension, the portability of the hybrid plan makes sense for the majority of workers, who switch between the public and private sectors, Hill said.
He’s wary of completely converting to a defined-contribution plan, however. Hill joined state government after a long career managing human resources at the wood-products giant Weyerhaeuser, which offers pensions.
“The bad thing about defined-contribution plans is the track record. Employees don’t make good investment choices,” Hill said. Workers lack the expertise, he said, and a professionally managed pension fund has a better shot at a good return.
Most people lack the sophistication to ensure a solid retirement on their own, said Dan Foster, the Vancouver financial planner.
“People are ruled by emotion when they need to make their investment decision with their brains,” Foster said. “Most retail investors cut gains short and let losses run.”
The National Institute on Retirement Security has calculated that those without pensions are six times more likely to fall into poverty in old age.
Hill believes that state and local governments would take the blame if public servants sank into poverty upon retirement because they didn’t save enough or their investments yielded poor returns.
Poverty is something Bivins won’t have to worry about. And he doesn’t apologize for it. There are good reasons for the state’s firefighter pension programs to set a lower retirement age, he said. “Do you want a 62-year-old firefighter pulling you out of a burning building? This is a young person’s game. It takes a toll.”
He figures he put in his time, socked away 6 percent of his paycheck in the state pension fund for three decades, and now it’s time for him to collect.
“When I got the job, in effect, I had a contract for service,” he said. “It’s unreasonable to expect 35 years later it should be changed because someone thinks it’s unfair.”