Background Briefing: The Hybrid Retirement Option
Why a limited pension hybrid option is preferable to a pure “401(k)” solution
401(k) is not allowed for governmental employees under the 1986 tax laws.
Most private citizens do not know that President Reagan’s 1986 tax reform act prohibited public employers from offering any more 401(k) accounts to their employees. Federal law allows public employees to receive defined contribution benefits through what are called 401(a) money purchase plans which require auniform contribution rate (no employee discretion, no changes in employer contributions without re-filing with IRS). Different employee groups can havedifferent rates, but the ground rules are different and must be understood by pension reformers. Employees may also contribute discretionary savings in a 457or 403(b) deferred compensation plan but there are limits on those programs.2.
Most California public employees do not receive Social Security benefits.
Asone of ten states that do not participate widely in Social Security, California public employers have chosen to provide retirement security through their pension plans, and must comply with Section 218 of the Social Security Act whichrequires minimum and comparable benefits for retirement, death and disability
A401(a) plan can be provided, but it must meet minimum benefits standards andcan readily be attacked as insufficient by expert critics. Public employees arerequired to participate in Medicare, incidentally.3.
Joining Social Security will cost California taxpayers
, not less.
Employers and employees in governmental pension plans typically save 2.3% of their salaries because they do not contribute to the income redistribution featuresof Social Security. By requiring them to join Social Security as some wouldsuggest, the costs to California taxpayers will automatically increase by 2.3% of payroll for most employees or more than $1 billion annually. Eventually we believe that Congress will require all new public employees to participate, but for now, there is a cost advantage that opponents of any such proposal will quickly point out.4.
Closing the defined benefit pension plans entirely will cost
Ina pension plan, the investment horizon is presumed to be indefinite. If we closeoff the current pension plans entirely for new employees, the plan is deemed“closed” by actuaries and this typically requires a lower discount rate and thus ahigher employer contribution. For an underfunded plan, it will increase costssignificantly. Furthermore, moving new employees into a defined contribution plan does not relieve the public employers of their constitutional obligations for current employees and retirees, which non-professionals do not understand5.
Pure defined contribution plans have failed in the public sector.
In Alaska,the stock market declines of 2008 left some public employees with less in their 100% defined contribution plan than they would have received under SocialSecurity, even though they had paid in more. In Colorado, public safety officersworking for cities that opted out of Social Security have experienced insufficientsavings in their 401(a) plans. In Nebraska, researchers showed that employeesearned materially less in their defined contribution accounts than the pensionfund.