Florida legislators are now considering a new pension reform proposal that would place newly hired state, county, K–12, and higher-education workers into a 401(k)-style defined-contribution retirement plan, unless they explicitly request to be enrolled in a traditional defined-benefit pension plan. New workers would be given eight months to decide which plan they prefer. The legislation would also add survivor benefits for first responders to the defined-contribution plan; these benefits are currently available only to workers enrolled in the defined-benefit plan.
The Florida Retirement System (FRS) is the pension plan for state employees; workers for cities, counties, and special districts; school boards; and workers in state colleges and universities. FRS currently has 622,000 members and 363,000 retirees.
While it would be easy for the state to leave its pension plans unchanged, Florida cannot afford to ignore the changing dynamics related to the state’s retirement system. Many pension funds have not adjusted their eligibility ages to reflect increases in average life expectancy. Since people are living longer, the lifetime pension benefits being provided to retirees, who can retire at ages much younger than those in the private sector, often remain on the books for decades.
Moving state workers to a defined-contribution model puts the state on a path towards lowering costs and improving flexibility. Workers covered by defined-benefit plans own and control their pensions and can change employers without losing their accrued benefits. Defined-contribution plans also benefit taxpayers because the pension plan burden does not rise automatically due to cost of living adjustments and because the defined-contribution model is more transparent, avoiding the accounting gimmicks governments currently use to hide liabilities.
Changing the default plan to a defined-contribution plan is important because data have shown many state workers choose the default plan to minimize the risk of making a mistake or choose not to take the time to review their options. According to the Florida State Board of Administration, in the third quarter of 2015, 22 percent of state workers chose the 401(k)-style plan, 17 percent actively chose the defined-benefit pension plan, and 61 percent were enrolled in the pension plan by default. Actuarial and employee benefits consulting firm Milliman, Inc. surveyed state workers in Florida and found 45 percent of the workers who chose the default option may have done so to avoid mistakes that they believed could have occurred if they had applied for a plan manually.
The James Madison Institute argues moving the state away from defined-benefit plans reduces the risk of underfunding: “As long as the state kicks in its promised contribution each year, its obligations are satisfied. Taxpayers 20 or 30 years down the road will not find themselves on the hook for many extra billions of dollars just because FRS made improper investments or a future Legislature authorized an unaffordable level of defined benefits.”
Florida legislators should also enact other pension-related reforms; it should lower FRS’ high assumed rate of return for its investments, raise the employee contribution rate, and lengthen vesting periods.
Florida’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 makes 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.
Florida Retirement System Reform: Why Now?
Randall Holcombe of the James Madison Institute argues the Florida Retirement System should move toward a defined-contribution system now to avoid significant financial problems that will likely occur in the future. Holcombe says these problems will occur because of the tremendous growth of unfunded liabilities, which are amassing as a result of the current defined-benefit system.
Pension Reform in Florida: Unfinished Business
The James Madison Institute (JMI) argues in this Policy Brief several supplemental changes would improve FRS’ financial stability. These supplemental changes include making a 401(k)-style “defined-contribution plan” the default choice for new hires who express no preference concerning their retirement options. JMI also argues legislators should limit the time horizon within which new employees may switch between the traditional defined-benefit plan and defined-contribution plans. Third, JMI says legislators should lengthen the vesting period on the state’s defined-benefit plan to 10 years. Fourth, JMI argues the employee contribution rate should be increased to 4 percent; the current rate is 3 percent.
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 in the 50 states and suggests ways states might go about solving their pension problems.
A Review of Defined Benefit, Defined Contribution, and Alternative Retirement Plans
This paper from the Texas Pension Review Board outlines plan design options and presents potential reforms and case studies based on changes already enacted in other states. The interests of the sponsoring entity and the plan participant are considered when evaluating how best to ensure participants are financially prepared to retire while maintaining the long-term solvency of the plans.
The Limits of Retrenchment: The Politics of Pension Reform
Daniel DiSalvo of the Manhattan Institute examines pension reform and argues states which 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.
Research & Commentary: Defined Contribution vs. Defined Benefit Pensions
John Nothdurft, director of government relations at The Heartland Institute, provides a bullet-point comparison of defined-benefit pension and defined-contribution retirement plans.
Research & Commentary: Public Pensions and the Assumed Rate of Return
Heartland Institute Senior Policy Analyst Matthew Glans examines the problems facing state and local pension funds, how assumed rates of return affect pension fund debt, and proposals to change the projected rates of return on pension fund investments.
Fixing the Public Sector Pension Problem: The (True) Path to Long-Term Reform
Richard C. Dreyfuss of the Manhattan Institute examines various state pension reform efforts and recommends states borrow a page from the private sector by shifting to defined-contribution plans: “Under such plans, to which employees as well as employers may contribute, investment risk is borne by plan members, not by taxpayers. A majority of Fortune 100 companies have already adopted such plans. Only 16 percent of large companies still offer their retirees medical coverage. By sharing a complex of risks with the beneficiaries, states and municipalities would be able to devote far more of their time and resources to the more immediate concerns of today’s voters and taxpayers.”
The Momentum Grows: Virginia Creates Mandatory Hybrid System
Adam Schwiebert of the Buckeye Institute discusses Virginia’s 2012 public pension reform legislation. “The end result is a plan that saves taxpayer dollars, spreads out investment risk, limits runaway liabilities, and provides a reliable source of retirement income for government retirees. While hybrid plans may not provide the savings or simplicity of pure defined-contribution plans, they are a strong first step in reining in runaway defined-benefit pensions.”
The Gathering Pension Storm: How Government Pension Plans Are Breaking the Bank and Strategies for Reform
The Reason Foundation tackles 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.
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website at http://news.heartland.org/fiscal,
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