Research & Commentary: Michigan Considers Moving to 401(k)s for Teachers

Published May 31, 2017

Despite having implemented several major reforms over the past two decades, many of Michigan’s pension systems remain deeply in debt and unable to handle the state’s growing liabilities and an aging pension population.

To address this problem, several lawmakers, in both houses of the Michigan Legislature, recently proposed a major pension reform plan that would move all new teachers to a 401(k)-style defined-contribution plan. The new bills would block enrollment in the Michigan Public Schools Employee Retirement System (MPSERS), which has accumulated a $29 billion unfunded liability, for new teachers beginning on September 30.

Under the new system, the State of Michigan would contribute 4 percent of a teacher’s wages toward the state’s retirement fund. Employees could choose to contribute an additional 3 percent, which would also be matched by the employer, this would incentivize savings and strengthen the individual accounts. The employer match would be covered by the state. Existing employees in the MPSERS system would continue to get their pension benefits.

Moving state workers to a defined-contribution model puts the state on a path towards lowering costs and improving flexibility. Under a defined-contribution plan, employers pay a fixed amount during the course of a worker’s career, this amount is then deposited into a personal account which the workers controls and manages, This allows the worker greater control over their retirement and the ability to customize it to their own needs. These plans not only give worker’s more control over their own money but give more budget certainty to taxpayers.

Such a plan would also stop the state from being able to hide the true cost of its retirement-plan liabilities. Mackinac argues that despite the fact Michigan is required to set aside funds for its pension plans by the state’s constitution, it has used accounting tricks to hide costs and rack up a considerable amount of debt.

Michigan has made several attempts in the past to reform its pension system. The current system used by MPSERS is a hybrid system that launched in 2012. It includes multiple options for employees. The default option combines a traditional pension plan with a tax-deferred investment account. The second option is a 401(k)-style plan. According to a May 2017 report in the Detroit Free Press, most new employees choose the default hybrid plan. Hybrid plans are a clear improvement over defined-benefit pension plans, but they still place a burden on the failing pension system, risking the retirement of both new and existing employees. 

In a press release issued by the Mackinac Center for Public Policy, James Hohman, assistant director of fiscal policy at Mackinac, argues the reforms are needed to stabilize the state’s pension system. “Each year, more and more education funding is held hostage by our broken pension system, so I’m glad to see a group of legislators is willing to do the hard work now to ensure school funding gets where it’s intended,” Hohman said. “It’s unfair for politicians to make promises to teachers and send future taxpayers the bill, and it’s wrong that funding intended to enrich today’s students is consumed by this out-of-control pension system.”

Mackinac notes the amount of tax dollars spent on pensions increases every year: “Today, state and local districts spend 37 percent of payroll on pensions, a number that has gone up from 12 percent in 2002. Of that money, 89 percent goes to pay down the unfunded liabilities created by decades of pension system mismanagement, and only 11 percent is used to fund the benefits that current employees will someday receive.”

Michigan’s effort to move state workers into a defined-contribution pension plan is an important step toward solidifying the state’s financial future. Defined-contribution plans give retirees direct control over retirement and make it possible for them to move in and out of the private sector without losing their accrued pension benefits. This allows governments to budget more accurately, because benefits are paid directly to employees and are firmly set each year. 

The following documents examine state pension reform in greater detail.

Pension Reform Legislation Benefits Students, Teachers and Taxpayers
The Mackinac Center for Public Policy examines a new plan to address Michigan’s $29.1 billion pension problem. The plan would move future school employees to defined-contribution plans. Mackinac argues such a proposal is necessary and a moral imperative.

Pension Reform Case Study: Michigan 2016 Update
In an article for the Reason Foundation, Anthony Randazzo examines Michigan’s pension reform efforts, arguing “while Michigan provides valuable insights for how to pursue adopting pension reform—such as taking sufficient time to fully analyze a pension plan’s problems, avoiding conflict by communicating with all parties, and having determined elected officials leading the effort—the state has also provided an example of how not to manage the implementation of pension reform.”

Not So Modest: Pension Benefits for Full-Career State Government Employees
Examining the benefits paid to state and local government employees, Andrew Biggs of the American Enterprise Institute argues drastic benefit reductions for current retirees would be unfair, but reforms to make public- and private-sector pensions more equitable should be on the table.

The State Public Pension Crisis: A 50-State Report Card
This Heartland Institute report examines problems facing public pension systems, including the enormous burdens public employee pensions pose in some locations. The report ranks each state according to the operation and relative disposition of the pension plans and suggests ways states might go about solving pension problems.

The Limits of Retrenchment: The Politics of Pension Reform
Daniel DiSalvo of the Manhattan Institute examines pension reform and argues states that are serious about keeping pension costs under control are increasingly introducing defined-contribution options or hybrid plans. As more states take this step, it will become less controversial and easier for other states.

Keeping the Promise: State Solutions for Government Pension Reform
This report from the American Legislative Exchange Council describes the variety of pension plans governments use today and the advantages and disadvantages of each plan. It also provides several tools legislators can use to ensure governments can affordably fund retirement benefits for their employees.

The Gathering Pension Storm: How Government Pension Plans Are Breaking the Bank and Strategies for Reform
The Reason Foundation discusses the looming crisis created by states’ continued use of defined-benefit pension plans, offering solutions and explaining why the current system is a disaster in the making.

Defined Contribution Pension Plans in the Public Sector: A Best Practice Benchmark Analysis
This white paper from the TIAA-CREF Institute “addresses best practice benchmarks for the design of public sector primary (core) defined contribution pension plans. It includes an examination of the environmental conditions and factors affecting these plans as well as general principles for the design of effective defined contribution plans. Selected public sector core defined contribution plans are reviewed against identified best practices.”


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