Ninety-two percent of state and local government full-time workers had access to defined benefit pension plans in 2011, but only 23 percent of full-time private workers had access, and a quarter were in frozen plans. This article discusses the problem with current traditional pensions plans, including the incentive structure of them that provides little reward for young workers that are mobile, locks in middle-aged workers even if they are unhappy or unproductive, and forces older workers to retire when they may not be ready to.
All traditional pension plans have three common features that can create very different benefits for workers performing the same job at the same pay level: the final benefit is not adjusted for inflation or interest from the time the employee leaves, until they start receiving benefits; the current system rewards work near the end of a career more than at the beginning; and once workers are eligible to retire, it is discouraged for them to continue working. Therefore, this current pension plan systemdiscriminates against many younger and senior workers, discouraging them from either entering or continuing with public service. On the other hand, many middle-aged workers, regardless of skill level, become locked into government employment because they would forfeit temporarily high pension benefits and, in other words, total compensation by leaving before retirement age.
Other article highlights include:
- Between ages 45 and 50, pension accruals average 72 percent of salary, and throughout the mid-fifties, pension accrual continues boosting compensation. However, once workers’ reach their late 50s, pension accruals turn negative because sacrificed retirement payments exceed the value of additional benefits earned in later years, causing pension wealth to fall. This loss in pension wealth reduces effective compensation by nearly a quarter in a worker’s early 60s, increasing in their late 60s and 70s.
- Very few workers in their 40s quit their jobs, even if they are unhappy or unproductive, because they stand to derive large pension bonuses by remaining on the payroll until they qualify for early retirement. This is not good for workers or for the state because even though the state may have locked in some great workers, it has also locked in some subpar workers.
- Additionally, the current pension plan design makes it hard for the state to retain experienced and effective older workers that are difficult to replace because workers hired at age 25 essentially forfeit a quarter of their pay each year if they remain on the job in their early sixties.These pay cuts induce many state employees to retire. While a benefit system that encouraged early retirement may have made sense in the past, it no longer does because the workforce is aging and it is not good to encourage still-productive older workers to retire.
How to Use
This article is important for city officials to consider when determining how to attract and retain the best workers, whether they are young, middle-aged, or older. Reconsidering current pension plans is one of the first steps in this process, and the information provided in this article, as well as the case study provided, are good starting points. Just knowing the effects of the current system and of alternative reforms can enhance the likelihood of developing compensation systems that better compensate employees with equal pay for equal work.