Mailbag: Pennsylvania’s Pension Crisis

MailbagSeveral readers wrote in with questions on my Philadelphia Inquirer op-ed from Sunday, “Pension Crisis is Going to Hit Hard.” Here are answers to some of the most common questions.

How does switching to a 401(k)-style plan for retirees do anything to fix the $40 billion liability we already have?

Switching to a 401(k) doesn’t diminish the current liability of $40 billion we have already, but it would contain the crisis and prevent it from getting worse. To say that a 401(k)-style plan does nothing for the current debt—and therefore isn’t worth much as a reform—is to say, “We have a hole in the hull and the ship’s started to sink. I guess we should keep poking new holes.”  We must first plug the hole, then work on bailing out the water.

Gov. Corbett’s proposal to reform the system includes modifying the unearned future benefits of current workers.  Both that and the plan for new hires would reduce future costs.  It’s unchartered legal territory, but it would reset the formula used to calculate pension benefits to the level it was before lawmakers enacted unsustainable increases, both prospectively and retroactively, in 2001.

You say a 401(k) plan requires the state and school districts to contribute a set amount every year. How so? Couldn’t the government just underfund the new plans as well?

Lawmakers can change the law in the future (up or down), but that either represents an instant cut in benefits or an instant requirement to contribute more. SB 2 would set that level at 6 percent of pay, whereas Gov. Corbett’s plan would be 4 percent (with higher employee contributions than SB 2).  Either way, the state and school districts would deposit that amount into a worker’s personal account while they are working.

Unlike the current system, neither the state nor school districts could simply choose not to pay what they owe on pensions. Neither can private employers without formally changing their defined contribution plans.  In a defined benefit plan, politicians can increase benefits today with promises to pay for them in the future. Defined contribution plans require a pay-as-you-go approach that take the politics out of pensions.

History has shown that “defined contributions” don’t work: They ultimately cost more than the plan that is in effect.

First, let’s explain some of the terms. “Defined benefit” plans guarantee a set level of yearly income for a retiree. For government workers, if stock market returns fall short on pension investments, then taxpayer contributions must cover the shortfall. By contrast, what’s “defined” in a defined contribution plan is how much an employer contributes regularly to a worker’s retirement plan. Defined contribution retirement plans must be paid as they’re earned, making them more affordable and predictable.

So if defined contribution plans were genuinely more costly, there would not have been a historic and overwhelming 30-year shift in the private sector from defined benefit retirement plans to defined contribution plans. Today, less than a third of Fortune 100 companies offer defined benefit plans only to new hires. Now government defined benefit plans from Illinois to California to the Keystone State are in trouble.