3 Reasons Cities Should Switch To
401ks, by John Sullivan, 5/29/17
Debt-laden pension
obligations continue to weigh on state and city governments around the country, with Chicago, Illinois as the most
recent example.
All told, municipalities
and states owe a combined $3.85 trillion in unfunded pension liabilities, The Hill recently reported. One solution to
prevent such situations in the future is, of course, switching from defined
benefit to defined contribution 401k-style plans, as seen with their private
sector counterparts.
While once feared for
the political fallout, voters are now stamping ballot-box approval on
reform-minded candidates willing to address these massive retirement
shortfalls, as they place entire budgets at risk (see Illinois). Scott Walker’s contentious reign in
Wisconsin comes to mind, as does Gina Raimondo in Rhode Island.
Wayne Winegarden with EfficientGov,
a website that “tracks innovative solutions to fiscal and operational
challenges facing cities and towns,” offers up three reasons to consider a
defined contribution move and save municipalities that are “headed to
pension-derived bankruptcy.”
No. 1: Funding falls short
State and local
governments have only contributed 88 percent of the required annual
contributions into their public pension funds between 2001 and 2015 Winegarden
writes, citing stats from the Brookings Institution. Additionally, according to
the Pew Charitable Trusts, public pension plans in total need an
additional $1.1 trillion just to meet current expected obligations. “This 28
percent funding gap understates the problem because it does not account for the
unfunded repayment risks that taxpayers are bearing on behalf of public
employees,” Winegarden adds.
No. 2: Unrealistic returns
Public pension funds
currently assume an unrealistic return on their investments. “Compared to their
private sector counterparts who assume an annual return a bit over 4
percent, public sector funds are, on average, assuming they can annually
earn around 7.5 percent. Assuming a better outcome does not make it so.
Should the overly optimistic returns not come to fruition, then the dire
financial state of the state and local public pension systems is even worse.”
No. 3: Risky business
Public pension funds are
carrying too much risk in their investment portfolios. “During the 1970s,
public pensions used to invest one-quarter of their assets in riskier
‘equity-like’ investments such as stocks, real estate, hedge funds and other
assets subject to substantial investment risk,” Winegarden writes. “Today,
public pension systems invest two-thirds of their assets into these types of
riskier investments.”
He concludes by arguing
that in order to start the transition to 401k plans, “all new employees should
be ineligible for the current defined benefit programs, and should instead be
enrolled in a defined contribution retirement system that meets the average
standards of large company defined contribution plans. These standards should
include no minimum length of service requirement for eligibility, immediate
vesting on matching contributions, and the government’s matching and
non-matching contributions equal to 6.5 percent of pay.”
“For current employees,”
he adds, “the current defined benefit programs should be frozen, specifically a
hard freeze. Under a hard freeze, no public employee would accrue any more
benefits in the defined benefit program.”
https://401kspecialistmag.com/3-reasons-cities-switch-401ks/#.WS0TVcm1tE4