Opinion: Switch to 401(k)-style plans a loser for pensioners, taxpayers

Last week, Republican legislative leadership proposed a “take it or leave it deal” in the midst of the budget stalemate. It would swap deep cuts in public employees’ retirement security for $300 million more to partially restore K through 12 education funding eliminated from Gov. Corbett’s 2011-2012 budget.

In exchange for education funding, the Republicans want Gov. Wolf to enact some version of Senate Bill 1, which would cut public pensions by creating a 401(k)-style plan for younger workers. The Republicans have offered a classic false choice: cuts to children or cuts to workers.

SB 1 is deeply flawed legislation. It won’t balance the budget or fund schools this year. And it would cost Pennsylvania taxpayers more in the future. Enacting SB 1 makes no more sense today than when it was a stand-alone bill that Gov. Wolf vetoed on July 9

First, SB 1 would illegally reduce benefits for current workers by up to 28 percent – workers who have contributed 7 percent of every paycheck for their own retirement. SB 1 cuts would likely be found unconstitutional; its passage would trigger lengthy and costly legal proceedings for the commonwealth. Future workers would experience larger benefit cuts, by as much as 70 percent, according to actuaries for Pennsylvania’s school employee retirement plan. Cuts that deep could make many future retirees eligible for welfare programs, another taxpayer cost.

Second, SB 1’s switch of new employees to 401(k)-style accounts would come with a steep cost to taxpayers. Individual accounts carry high Wall Street management fees while delivering low, but high-risk, returns for Main Street retirees. The unwise combination of high costs, high risks, and low returns would result in SB 1 reducing retirement security and costing taxpayers more.

Third, shifting new employees to 401(k)-type plans drains contributions from Pennsylvania’s traditional pensions: when the only people left are in or near retirement, plan managers would have to invest more conservatively and get lower returns, further increasing the state’s pension debt.

I’m not theorizing or speculating here. State experiments with 401(k)-style transitions have experienced nothing but problems. Michigan started enrolling all new state employees in a 401(k)-style plan in 1997. In 13 years, the state retirement system’s unfunded liability increased sixfold. Alaska, too, switched state and public school employees to a 401(k)-style system in 2006. By 2013, pension debt doubled to $12.4 billion.

West Virginia has the most telling story of all, what one administrator called their “red truck” problem. Retirees were advised to take lump sums from their accounts; some bought cars and trucks, leaving them too little on which to live. In just 15 years after the 1991 transition to a 401(k)-style plan, lawmakers reopened the traditional pensions because a growing number of retirees with individual accounts were dependent on taxpayer-funded social programs. The switch back improved both retirement security and the health of the system, which is now funded at 58 percent rather than 25 percent.

But let’s bring appropriate pension design right here to Pennsylvania. Five years ago, the legislature compromised and enacted Act 120 which maintained Pennsylvania’s defined benefit system and curbed benefits for new workers to help pare down the state’s unfunded liabilities over the course of 30-some odd years. Those reforms are working.

According to the Pennsylvania Employee Retirement Commission, SB 1 does not pay down the unfunded liability any faster than Act 120. The difference is that SB 1 drastically cuts pensions, just as the nation is heading towards a retirement crisis.

Republicans are attempting a devil’s no-win bargain — pensions for education. The trade off is false and overlooks the structural problems in 401(k)-type plans. The truth is SB 1 is a short-term political ploy that could devastate Pennsylvania’s public workers and taxpayers for decades to come.

Gov. Wolf was right to veto SB 1 when it got to his desk back in July. It’s time for lawmakers to understand that, and to develop a responsible approach on pensions and education that saves money and preserves retirement security and quality schools.

Teresa Ghilarducci is an economist and nationally-recognized expert in retirement security. She holds the Bernard L. and Irene Schwartz Chair in Economic Policy Analysis in the Department of Economics at The New School for Social Research and directs the Schwartz Center for Economic Policy Analysis (SCEPA) that focuses on economic policy research and outreach.