New Jersey’s current total pension liability is $115 billion, making it one of the worst-funded pension systems in the country. To put this in perspective, New Jersey’s pension debt exceeds its $37.4 billion annual budget. The state pension system covers nearly 800,000 current and retired public employees. The New Jersey Legislature is now considering a pension reform plan developed last year by the bipartisan Economic and Fiscal Policy Working Group who recommended moving younger workers out of the traditional pension plan and into a proposed defined-contribution retirement system.
The new proposal would create a hybrid pension plan for teachers and non-uniformed state, county, and municipal employees who are new hires or have less than five years of service. The new plan has two components. First, it would provide a defined benefit plan on the first $40,000 of income. Second, it would provide a cash balance account on income more than $40,000.
Under a defined-contribution plan, employers contribute a fixed amount over the course of an employee’s tenure, which is invested into a 401(k)-style retirement account the employee manages. This gives employees control over their retirements. Furthermore, this provides a more stable and predictable long-term budget outlook.
On the other hand, a defined-benefit plan is the traditional pension model in which an employee’s pension payment is calculated according to length of service and the salary they earned at the time of retirement. These plans have several major flaws which allow employees to inflate their pensions beyond what is both necessary and sustainable. For years, elected officials have guaranteed defined-benefit pension benefits to government employees but have not been adequately funding them and shifting the cost of the plans onto future taxpayers. Adding to this problem is the fact that most taxpayers are unaware of how much it will cost to keep these pensions afloat in the future.
Cash balance (CB) plans feature the benefits of defined-benefit and defined-contribution plans. CB plans provide guaranteed monthly retirement income, use of pooled investments, and access to annuities. By setting a minimum investment return and sharing any additional earnings, a CB plan helps employers gain predictability over costs, which safeguards state budgets during down periods while ensuring employees receive their benefits.
New Jersey’s pension shortfall has been compounded by its unrealistic expectations for its investment returns. Currently, New Jersey assumes its investment portfolio will earn 7.5 percent annually. New Jersey legislators should consider lowering the assumed investment return rate to a more realistic level. Pension experts recommend states use an expected rate of return from 2.3 percent to 3.1 percent, figures based on Treasury bond yields.
Although a hybrid model will not eliminate all of New Jersey’s pension problems, it will limit the rapid growth of unfunded liabilities. Defined-contribution and CB plans give retirees direct control over their retirement nest eggs and enable them to move in and out of the private sector without losing accrued pension benefits. They also allow governments to budget more accurately because benefits are paid directly to employees in a defined amount each year.
The following articles examine state pension reform from multiple perspectives.
Hidden Debt, Hidden Deficits: 2017 Edition
In this study, Joshua D. Rauh of the Hoover Institution applies market valuation to pension liabilities for 649 state and local pension funds and says that despite the introduction of new accounting standards, the vast majority of state and local governments continue to understate their pension costs and liabilities by relying on investment return assumptions that range from 7 percent to 8 percent per year.
Pension Reform Handbook: A Starter Guide for Reformers
This paper by Lance Christensen and Adrian Moore of the Reason Foundation considers many of the problems that troubled pension systems often experience. The authors also outline several principles they believe should be used as part of any pension reform effort.
Public Pension Cash Balance Plans: A Primer
In this Issue Brief from The Pew Charitable Trusts, the authors argue a well-designed cash balance plan can help government employers meet their recruitment and retention goals while keeping costs down and improving long term fiscal stability.
The Path to Public Pension Reform
In this Policy Briefing, Eileen Norcross and Olivia Gonzalez of the Mercatus Center at George Mason University discuss pension reform. They argue true reform must address “the inherent problems of public-sector accounting and management of pension funds and consider the benefits of defined contribution plans for public-sector workers. Reforms should be equitable for all generations, fund retirement benefits adequately, and have a plan for funding legacy obligations.”
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