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Analysis: New plans may not save public pensions

Oct 3, 2011, 9:51 a.m.

By Lisa Lambert

WASHINGTON (Reuters) - To fix their persistent pension problems, some U.S. states are looking to reshape their retirement plans to resemble those in the private sector, but they may find may employees resistant and the savings elusive.

Over the last few decades, the private sector has ditched traditional pension plans with their defined benefits. They have been replaced with defined contribution accounts, such as 401(k)s, in which employees allocate a set amount each month to invest -- often partly matched by employers -- and then cash out at retirement.

This has left the public sector as the main provider of defined benefit plans, which pay employees a fixed amount each month after retiring.

But pension funds have been stung by the recent financial crisis and recession, leaving taxpayers and political leaders agonizing over the possibility they will be unable to afford those defined payments. Estimates of a total shortfall range from around $700 billion to $3 trillion, due to differing forecasts of investment returns.

"If the idea is that tax revenues are down and state budgets are crunched, and they surely are ... I think it's worthwhile to take a step back and look at the actual costs," said Ilana Boivie, director of programs for the National Institute on Retirement Security, or NIRS

"Most states that have done those feasibility studies have found that you're not going to save any money" by switching to a defined contribution plan.

According to the National Conference of Public Employee Retirement Systems, the next two years will see "modest growth" in hybrid plans that combine elements of the defined benefit and defined contribution schemes. Around 5 percent of public entities already offer hybrids.

About 20 percent provide defined contribution plans, and around 5 percent will add a defined contribution option in the next two years.

Some states want to keep current employees in pensions and put new hires into defined contribution plans.

Alaska, the District of Columbia, and Michigan all use defined contribution plans as their primary retirement offerings. In July, Utah began requiring employees to choose between a defined contribution plan and a hybrid. Minnesota offers three defined benefit plans but also manages a defined contribution plan for elected officials, city managers, and ambulance service and medical personnel.

The NIRS, in a study released on Thursday, found that moving into a system similar to 401(k) accounts can push up costs, especially at the start.

"That unfunded liability represents a debt that is a benefit promised and owed," said Boivie. "That unfunded liability will not go away."

When the defined benefit plan is closed to new members, employees and employer contributions to the plan could spike because the time span for wiping out funding gaps will be shorter and new employees will be putting money into their own retirement accounts instead of the pension plan.

Meanwhile, employers must bear the administrative costs for both plans as they phase out the pension program.

Defined benefit plans pool risks to achieve greater investment returns, the NIRS report found. They are able to "provide the same retirement income at about half the cost of a defined contribution plan."

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