Forget the false choice between defined benefit and 401(k) style plans for public pensions: A hybrid is better – WP Original
By: Mark Glennon
A false choice dominates much of the public pension reform debate. Public pensions today are mostly “defined benefit plans.” They promise retirees certain amounts hell or high water (in theory) — irrespective of returns on the pension’s underlying investments or the economy in general. Replacing them with something like the 401(k) plans common in the private sector is widely discussed. With those plans, the employees pick their investments and returns are uncertain.
A far preferable alternative to either is a hybrid plan. Some legislators are starting to talk up hybrids behind the scenes. Getting serious about them remains long overdue — but inevitable.
The point of a hybrid plan would be to provide a safety net at least comparable to what Social Security provides in the private sector. Social Security ensures that most private sector retirees won’t rot on the streets, no matter how unlucky or foolish they might be with their other retirement assets. But most public pension participants aren’t eligible for Social Security, for complicated, historical reasons.
With a hybrid plan a portion of retirement money would go into a plan that safely promises at least some level of fixed income after a true retirement age. Permissible underlying investments would be limited to highly rated fixed income securities, annuity contracts offered by rated issuers or the like. The rest would go into something 401(k)-like where the employees could choose their investments, including riskier assets like stocks.
That’s another rationale of a hybrid. We should all share a stake in the economy. All of us, in both the public or private sectors, should have our wealth in retirement depend at least partially on a healthy economy — general prosperity. That sense of a shared stake is undermined by defined benefit pensions, which are designed to pay the same no matter how poor or rich the rest of society becomes. Those pensions have contributed heavily to the ‘us versus them’ hostility between public and private workers so rampant today.
How much should be in each part? What investments should be allowed in each part? Fair questions for debate, and there would be plenty of details to work out. The Illinois Policy Institute has offered one version of a hybrid plan for Chicago. Their answers on the specifics may or may not be right, but credit them with pointing the discussion in the right direction.
Debate those specifics, but this much is clear: 1) We’re not going to let the elderly who invest poorly or blow their retirement money rot in the streets. Taxpayers will end up keeping them out of poverty somehow, as they should, so we might as well think rationally about what kind of safety net to offer and how to pay for it. 2) Defined benefit plans run by politicians stink. They are corrupt, corrupting, divisive, opaque, hopelessly subject to manipulation, unpredictably costly for taxpayers and, at the end of the day, provide no real security for retirees.
Let’s get on with considering a hybrid replacement that addresses both those realities.