Swapping a 401(K) for a Public Pension Isn’t Reform: Pennsylvania
The State of Pennsylvania is giving serious consideration to a proposal that would end the defined benefit plan for new state employees and replace it with a 401(K) plan (technically I think it would be a 401(B)). Pennsylvania is one of those states that face a huge unfunded pension liability, no matter how you discount the liabilities (see, “Economic Meet Politics in Public Pension Accounting [July 8, 2013]”). The Pennsylvania gap is estimated at $60 to $70 billion.
Governor Tom Corbett offered the 401(K) proposal as part of a broader reform to restructure benefit payments to existing beneficiaries of Pennsylvania’s public pensions. As the Pennsylvania legislative session winds down, all that remains of the broader reform is a proposal to offer 401(K)s to new employees. However, under the surviving proposal state troopers and corrections officers would not lose their defined benefit pensions.
As I’ve explained on numerous occasions, 401(K) plans are vastly inferior to defined benefit plans when it comes to providing retirement benefits. At best, the 401(K) is useful as a supplemental plan, but it leaves most retirees at great risk of exhausting their financial resources at a most inopportune time: while they are still alive. Nonetheless, the 401(K) has been a useful mechanism for shifting the risk from employers to employees in the corporate sector and in a few states.
Governor Corbett’s budget gurus might do a bit of math before they endorse this proposal. The existing deficiency wouldn’t get any smaller. It’s just that new employees (absent sensible reforms) wouldn’t contribute to making the pension deficit any bigger. By excluding new employees, the Pennsylvania pension plans would lose the contributions new employees would other be required to make (6.25% for state employees, 7.40% for teachers). This is money that would have been available to pay for benefits or to be invested. At the same time, administrative expenses will rise as Pennsylvania will be running two pension systems, and the new 401(K) system will be much more expensive on a per capita basis.
As to that long-term deficit that isn’t being addressed: it will, in fact, grow larger. If Pennsylvania puts a 401(K) plan into place, it can rest assured that twenty to thirty years from now, there will be more former public employees and teachers requiring public services because they will be living in poverty. If the 401(K) proposal goes through, Pennsylvanians will continue to face a huge pension deficit and higher social spending, while Pennsylvania’s politicians will have incurred a large moral deficit.
 This is a major difference between private and public sector pensions. Private DB plans do not require and employee contribution. In public plans, employees are a major and consistent source of funding. For example, in NC public employees have contributed $12.6 billion to their pensions, while government has only put in $7.8 billion (see, “Confronting Our Pension Challenge in North Carolina, [May 2, 2013]).”