Roughly five years after Gov. Corbett first began an effort to eliminate guaranteed pensions for future school and state employees, Gov. Wolf today signed a bill that reduces the guaranteed portion of future pensions by about three-eighths (because the pension increases with each year of service by 1.25% of final salary instead of 2%). Alongside this smaller guaranteed pension, future employees will receive a 401(k)-style savings account. If these savings are converted into a second monthly check – an “annuity” – “actuaries” estimate (Table 9, p. 19) that the total retirement benefit for future career employees will be within 16% to 18% of the retirement benefit received by employees under the prior (Act 120) pension plan (enacted in 2010).
In sum, the enacted pension compromise is a smaller cut in benefits than earlier “hybrid” (combined DB-DC) proposals (such as this one with a smaller DB multiplier). Together with Social Security, the new hybrid pension will maintain retirement security for future school and state employees.
It is not the bill we would have negotiated. Alongside the benefits cut, some future employees will contribute more of their own pay to their retirement, a further reduction in total employee compensation (wages plus benefits). The bill will thus increase the overall compensation penalty experienced by Pennsylvania public sector workers relative to comparable (e.g., similarly educated) private employees.
We also thought there were better ways to protect the taxpayer against future unfunded liabilities than moving away from traditional pensions, which are more efficient (have higher returns and lower fees) than individual defined contribution savings accounts. As we’ve said before, it’s hard to save money by switching future employees partly to retirement options (defined contribution savings) that cost more for any given amount of retirement benefit than a traditional pooled pension.
But with the pension compromise signed into law, it’s now time to make the best of the situation. Here are two ways:
1. For future state and school employees, the quality of their defined contribution savings plans matters. The lower the fees and the higher the returns on those savings accounts, the smaller will be the cut in retirement benefits experienced by future workers compared to current (in other words, that retirement benefit cut could be a lot less than 16% to 18% for future career employees with high-quality DC savings accounts). Pennsylvania needs DC savings options along the lines of the “ideal” (low-cost, high-return) defined contribution option described by the National Institute on Retirement Security. The compromise bill got off to a good start in this respect by providing for the pension systems to administer a (third-party) annuity option that would convert future workers’ DC savings into a monthly payout. This approach uses the buying clout of many DC accounts to reduce the cost of an annuity compared to some private annuity providers. The buying power of many DC accounts should also be used to drive down fees for the savings options into which future public workers may put their future individual savings.
2. Second, the passage of the compromise creates an opportunity to refocus discussion on the real retirement security issue in Pennsylvania – the collapse of retirement security in the private sector. Below the radar, Republican Senator Pat Browne and Democratic Senator Art Haywood have been pursuing a modest bipartisan approach to redressing this collapse: having the state give the roughly three million Pennsylvania private workers with no retirement plan through their job access to the kinds of individual savings account public workers will now have as part of the public-sector pension compromise. (Read to the third paragraph from the end of this editorial board memo for a summary of the Browne-Haywood co-sponsorship memo.)
The same common-sense ideas that will maximize the retirement benefit for future public workers from their individual savings account – minimize the fees, maximize the returns, have the retirement systems provide a (third-party) annuity at lower cost than available for individuals on the market – make sense for private workers. While optional – meaning workers should not have to participate – employees of employers that have no retirement plan should be “automatically enrolled” unless they explicitly elect not to participate. This auto-enroll feature dramatically increases the share of employees that save for retirement compared to a “default” under which people do NOT participate unless they explicitly elect to do so. Having most of the three million people who now have no retirement savings through their job would be a major victory for retirement security in Pennsylvania.
In addition to doing the best we can for future public, and for private, employees now that the pension compromise is in place, here’s another opportunity opened up by today’s signing: the legislature can now focus on issues that matter more to most Pennsylvanians than public sector pensions. We’re looking forward to more discussion of education, jobs, and the critical services vital to improving the lives of hundreds of thousands of Pennsylvanians – and to an on-time state budget that puts people first.