Should States Adopt Defined-Contribution Plans?

Leo Kolivakis's picture

Via Pension Pulse.

Blogging for Reuters, Felix Salmon comments, Why states shouldn’t adopt defined-contribution pensions:

Steven Greenhouse has a long article in today’s NYT about an attempt by the states to deal with their “strained” pension funds by moving to defined-contribution pension plans. Here’s the lede:

Lawmakers and governors in many states, faced with huge shortfalls in employee pension funds, are turning to a strategy that a lot of private companies adopted years ago: moving workers away from guaranteed pension plans and toward 401(k)-type retirement savings plans.

What’s a “huge shortfall”? Amazingly, nowhere in the 1,500-word article does Greenhouse actually say. Instead, we get incomprehensible tales like this:

Utah decided to adopt a 401(k)-type plan after the stock market plunge in 2008 caused the shortfall in the state’s pension plan to balloon to $6.5 billion…


Under the new plan, [state senator Dan] Liljenquist said, the state’s retirement contributions for new workers will be roughly half that for current employees, potentially saving $5 million a year for every 1,000 new workers hired.

So, the state of Utah has been putting insufficient money into its pension plan, and now there isn’t enough money there to meet upcoming liabilities. And the solution here is for the state, in future, to contribute “roughly half” of what it’s been spending up until now in pension contributions.


Needless to say, this makes no sense on either front. The liability to existing workers doesn’t go away if a different plan is adopted for new workers, so the problems at the pension plan aren’t being addressed. On top of that, it’s hard to see how contributing much less to new workers’ retirement is going to help them at all, either. From a pensions perspective, there’s no winner at all: the only entity better off is the state, from a cashflow perspective.


On top of that, Greenhouse makes no attempt to put numbers like $6.5 billion or $5 million in any kind of context. Are they big? Who knows.

The only way I could make any sense at all of Greenhouse’s article was to read it in parallel with Dean Baker’s paper on the origins and severity of the public pension crisis. The table he includes, which includes all state public pension funds, is invaluable; here, for instance, is Utah.




What this shows is that the Utah pension fund, at the end of 2009, was about $2.8 billion in the hole. If it rose by 15% in 2010, which is a pretty reasonable assumption given the performance of the stock market, the gap is likely to have been all but eliminated. But even the gap at the end of 2009 was less than one tenth of one percent of Utah’s state income.


All of these numbers are fuzzy, of course. Valuing assets is hard enough; coming up with a present value of future liabilities is much harder, and depends crucially on which discount rate you use. But Baker’s numbers are pretty reasonable, and show that there really isn’t anything to panic about here.


More generally, as Teresa Ghilarducci notes elsewhere on the NYT website (but not in the paper), the idea that moving from defined-benefit to defined-contribution plans is going to help anybody at all is highly problematic.

401(k) plans are bad deal for taxpayers. Dollar for dollar, a traditional pension plan yields more pension benefits than do 401(k) plans because 401(k) management and investment fees are three times higher. And professionals who manage money in pooled pension funds usually get higher returns than workers who manage their own 401(k) accounts. The only clear winners when pensions switch over to the 401(k) plans are brokers and bankers…


The unintended effect of widespread 401(k) plans is more volatility. In contrast to traditional pensions and Social Security, 401(k) plans fuel bubbles and make recessions worse. When the economy is booming, 401(k) plan asset values soar, making people spend more and work less. Not what you want in an expansion.


Worse, when the economy plummets and takes 401(k) assets with it, people do the opposite; they cling to the labor market and rein in spending – again, two things you don’t want in a recession.

On top of that, defined-benefit plans have a mutual-insurance component to them: shorter-lived workers subsidize longer-lived workers, helping to increase everybody’s standard of living.


The fact is that the states’ move to defined-contribution plans is a blatantly political one, born of Republican ideology conflating such plans with individual freedom and choice. For rich professionals who jump from job to job every few years, 401(k) plans do make a certain amount of sense. For public servants spending a lifetime in the police force or in elementary schools, by contrast, they emphatically don’t. As for the state pension plans, the only way that the state governments can help them make up their actuarial liabilities is if they pour more money into them. Not less.

In his comment in Forbes, E.D. Kain takes it a step further:

Worse, defined-contribution plans open up a Pandora’s box of potential problems down the road. Take the case of the West Virginia. In 1991 West Virginia lawmakers ended their defined-benefit plans for new teachers. All teachers hired after 1991 were placed on a 401(k)-style plan. Under a 401(k) employees pay into a personal retirement account and employers match their contributions up to a certain amount. This money is invested in stocks and bonds and is often left to the employee to manage. It’s also tax-free up to a certain percentage of income, and portable. But it turns out, 401(k) plans are not for everyone:

Fast forward to today. It turns out that for a very large segment of West Virginia teachers, the 401(k)-type plan hasn’t panned out too well. According to a study done by West Virginia’s Consolidated Public Retirement Board, the average account balance is just $33,944 and only a handful of teachers age 60 or older have amassed more than $100,000 in their accounts – a fraction of what the pension plan would’ve paid.


What happened? Despite receiving an annual matching contribution equal to 7.5% of their pay, many teachers are claiming that they were improperly steered into low-yielding annuities, even though the plan offered more appropriate investment choices. Others say they received no guidance or education on such important topics as asset allocation and rebalancing.


So the West Virginia teachers now want a do-over. Essentially, they want to treat the past 17 years under the 401(k)-style system as though it never happened. They are asking to be put back – retroactively – into the traditional defined-benefit pension plan. Like a bad dream, their paltry 401(k) balances will disappear, to be replaced by the more generous pensions they would have racked up had they been in the traditional plan all along.


Of course, millions of private-sector workers would also like a second chance. According to an analysis of 20 million 401(k) participants conducted by the Employee Benefit Research Institute and the Investment Company Institute, the median account balance of a worker in his or her 60’s, making between $40,000 and $60,000 a year (in the same ballpark as a retiring West Virginia teacher) was $97,588 at the end of 2006. To put that amount in perspective, it would generate only about $8,000 a year in retirement income if it were invested in an immediate annuity.

But back to West Virginia. Incredibly, the state legislature has already agreed to go along with this retroactive pension switchover – as long as 65 percent of teachers formally elect to make the voluntary changeover.

Did you catch that? The average balance on these plans was just $33,944 – not exactly a nest egg. Spread over just twenty years of retirement, that only gets you a little over $140/month. The median account balance at retirement of private-sector workers on a 401(k) plan is only $97,588, or just over $400/month. Compare this with a defined benefit of say $2,500/month for twenty years – the equivalent of a $30,000/year pension – and you get a total benefit of $600,000. This should give you a sense of how difficult 401(k) plans are to scale across the American workforce. As Salmon correctly notes:

The fact is that the states’ move to defined-contribution plans is a blatantly political one, born of Republican ideology conflating such plans with individual freedom and choice. For rich professionals who jump from job to job every few years, 401(k) plans do make a certain amount of sense. For public servants spending a lifetime in the police force or in elementary schools, by contrast, they emphatically don’t. As for the state pension plans, the only way that the state governments can help them make up their actuarial liabilities is if they pour more money into them. Not less.

Well that’s not the only way states can help their pension funds. They can also manage them more wisely and not put as much faith into Wall Street. The financial collapse and the housing bubble are the reasons these plans are in crisis to begin with after all.

Let me comment on these posts. Felix Salmon rightly notes that states like Utah have been putting insufficient money into their pension plans, exacerbating pension deficits. But he also questions the magnitude of pension deficits, alluding to Dean Baker’s paper on the origins and severity of the public pension crisis.

I'm not going to question Dean Baker's paper and I agree that the problem of pension deficits has been blown way out of proportion for ideological reasons. Having said this, deficits are real and they require tough political choices ahead which include increasing contribution rates, cutting cost-of-living adjustments, cutting benefits and if need be, raising taxes. Relying on rosy investment projections to deal with chronically underfunded pension plans is simply irresponsible and taxing the private sector which is still reeling after the 2008 crisis is political suicide.

But moving into defined-contribution (DC) plans is not the solution. I've said it before, defined-contribution plans have been a disaster for workers looking to retire comfortably. They underperform large, well-managed defined-benefit (DB) plans for the reasons cited above, namely, they're expensive (fees are outrageous), volatile, badly managed, and they don't have the best interest of workers at heart (just those of brokers and bankers).

Let me add this: large, well governed defined-benefit plans are able to manage assets internally as well as invest in the best public and private funds around the world. For example, look at the Canada Pension Plan Investment Board's (CPPIB) external partners in public markets, private equity and real estate. Do you really think any DC plan can compete over a long period with a large DB plan that's able to pool billions and invest in these top managers? Not in a million years.

Moreover, defined-benefit plans end up costing society a lot less over the long-term because they cut the rate of pension poverty, as well as cut the fees paid out to brokers, banks and insurance companies. But when ideology takes over, the arguments against DB plans become ridiculous: "It's socialism, communism, a reason to raise taxes!". Give me a break! There are problems with DB plans but the rush to scrap them and replace them with DC plans will only make matters worse, ensuring more pension poverty down the road.

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cranky-old-geezer's picture

Leo, you're telling us how you think deck chairs should be arranged on the Titanic.

All govt controlled pension / retirement plans will be raided and looted. 

That's the real story.

Greater Fool's picture

I first of all don't agree that it's too late to do something about this. Defined-benefit plans are not rocket science to structure in a good way, but states have routinely shirked their duties--which of course include funding them, but more generally and crucially consist of acting to reduce their risk. When the sponsoring entity has taxation power and easy access to debt markets, there is absolutely no reason they should ever have to come crying to anyone to help them "bail out" their pension obligations, but this seems to be route states are heading. I can sit down with a team of five grad students who know the merest bit about structured finance and come up with something that serves the purpose and can actually be a source of revenue to the states at times. Yet another illustration of how the political system radically fails to solve the problems it sets itself.

Bruce Krasting's picture

Leo isn't the problem with DB plans is that they "assume" a rate of growth of 8-10% and they never achieve that.

So the problem with DB is that it is a lie??


Leo Kolivakis's picture


That's part of the problem which I alluded to, rosy investment assumptions. But this can be dealt with. The bigger problem is governance and the fact that state governments didn't bother topping out these pensions for years. DB plans aren't nirvana but they kill DC question about it. You just got to get the funding right.

JimboJammer's picture

401 k   accounts  should  be  converted  to 

Silver  and  Gold  in  hand... ASAP


simpleminds's picture

I agree that it is a little to late for addressing these issues.  I am not against defined benefit plans so long as they are funded 100% by the people receiving the benefit as well as including the provision that if investment returns do not turn out as expected, then the plan participants take a payout haircut until the plan's funds get back in line without the desired payouts.

cranky-old-geezer's picture

I'm amused at all the shoulda-woulda-coulda  proposals here.  It's like discussing how deck chairs should be arranged on the Titanic.  It'll all be at the bottom of the ocean shortly.

All government controlled pension plans and retirement plans will be raided and looted.  It's already happening.  

What little is left for the retiree, if anything at all, will have less and less purchasing power as Bernokio continues debasing the dollar toward worthlessness, his stated plan.

ebworthen's picture



"Would you like some ice in your Martini?"

Deck chair and Martini near the band please...


AnAnonymous's picture

All government controlled pension plans and retirement plans will be raided and looted.  It's already happening.  


Expansion knows only one cure: more expansion.

So far, expansionists were busy with raiding and looting assets in other countries, with full consent of the US population.

Now, it is time for chicken to come home to roost.

Government funds which were given a bit of protection, are now high on target list priority.

cranky-old-geezer's picture

"Criminality knows only one cure: more criminality."

Fixed it.

Toburk's picture

Didn't Sweden get rid of their defined benefit plans in the 90's?  Something about them being politically charged ponzi schemes that are guaranteed to collapse and leave everyone hurting?


I don't see why defined contribution plans can't be pooled in the way DB plans are, or at least that be one of the options open.  If DB plans are "so much better", why not allow private citizens to buy into one?  If such a thing cannot be done without a government guarantee and honest accounting how can a normal DB plan possibly work?


CPL's picture

That requires government debt, there would be a conflict of interest if the public were allowed to invest into them.  At least that is the reasoning.

RagnarDanneskjold's picture

The problem with Defined Benefit was your company could go broke. The problem with Defined Contribution is the fees and individual responsibility. 

Why isn't there a hybrid system where the individual owns their slice of the pension fund? The company pays a defined contribution and their responsibility ends there. An insurer/pension fund manages at a low fee, and the benefits are paid to the individual.

ebworthen's picture



They don't give a shit.

Honestly, what about all this don't you understand?

This is the new serfdom via a "defined investment plan", either pension, 401K, SS, whatever.

The goal is the theft of 30-40-50 or more years of hard labor from the masses, regardless of the government or political bent.

How could you look at the past 10 years and not see this?

Are you a shill or just plain delusional?

Wake the phuck up, really.


FreedomGuy's picture

Defined contribution is the ONLY way to go barring just saving for yourself. Defined contribution is real life. Even with no plans we would all take some portion of our income and invest where we thought best. No one knows how it would turn out over time.

Defined benefit is a promise that has to assume either the private company or the government will never go out of business. GM goes under with its pensions. Now government will not go under but it can go bust. Unions don't give a crap about that because they will demand that government shake down the citizens in the private sector for whatever financial promises have been made by the stupid people elected. In the end, the public will actually become the financial servants of the government and its unions. That's why there should be no public unions. Unionized public servants will end up making the public their servants.

Personally, I would prefer no company or government retirement plans. Just pay us the money in salary and make our own plans. Like all things in life some will do better than others, but all will have the same ability and gain a large measure of personal freedom in the process. Now, that is a good deal.

vxpatel's picture

CEOs look at the financial obligation of retirement, for their employees, as an unnecessary expense to be eliminated, remember they have their own pension plans. For decades they've been donating to congressional campaigns and getting time with their congressmen so they can make their case – pensions are disastrous for our corporations and hold our country back, preventing us from being competitive with 3rd world slave shops and call centers, where people work night and day for a few dollars per day. They'll press their point with our congressmen over fine wine, martinis and big steak dinners at the finest restaurants after playing a few rounds of golf in warm, sunny places, until the congressmen feels their pain. How can we compete?

CPL's picture

And what makes the people of Europe and North America any different?

Nothing at all.

Besides when is the last time you heard of a company with a fully defined pension plan that actually paid anyone after 1998?

vxpatel's picture

Besides, the point of the story was the fact that corporations have been bribing congress for decades...both parties....and we're OK with that...

Charlie Brown's picture

In case anybody is wondering, the actual answer to this question is 2 (your question implies a plan that is fully-funded, or over-funded). And, yes indeed, you read that correctly: 2 pension plans (currently) fit this description (within North America).

I'm in one of them, and I get to see the numbers (only once per year, but I do get to see them). For the curious, it's a pension run by a private company that manufactures a product that the US Fed has defined as a durable good, and it has (roughly) 6,000 Employees. It's located in Minnesota.

The reason, by the way, that the pension is over-funded is that it's a family-run business, and the person at the top insists upon (slightly) over-funding it. The person who made this decision is a profoundly honorable human being; the company itself was one of the very first, ever, to pay something that we today call "profit sharing" (as far back as the 1920's).

Rare, yes.

But it DOES indeed exist.

If Tyler wants to know, I'll be happy to verify it, and name it specifically via private eMail.

Other than that, the name of the firm stays confidential.

(My purpose here is to actually answer your question, not to bicker. You DID want an answer, right...?)

CPL's picture

private company


Two words right there.  You will be alright.  As soon as any sniffing around on going public.  Run for the exit.  Levi's and McDonalds' used to be a nice companies to work for as well...then..sigh.

Joseph Jones's picture

Man, I thought I loved reading this website.  But it seems the more I read the less I understand.  It's getting disheartening. 

gorillaonyourback's picture

thats a sign of a mind being freed from the chains of absolutism, congratulations :)

lynnybee's picture

Or, we can just do things like our grandparents did !!!   Save money in an interest bearing savings account !!!  & take responsibility for ourselves !!    My grandparents were just fine, worked hard, had a 15 year mortgage that was paid off in 10 years, a small social security check & money saved in a savings account in their local bank !!!    ...... 401k, Greenspan, scam to throw money towards WALL ST.

ebworthen's picture


Right lynnbee - that was back when you paid your Doctor what you paid your plumber.

That was when you didn't have to reverse mortgage the home you worked 30 years to pay off to get treated for a common disease.

That was when you could earn more than 1% on your savings.

That was when $14 trillion of the future generations hadn't been sold out for 6,000 points on the DOW.

Yes, you are right, 401K was a scam to FORCE private dollars into Wall Street for the elites and their cronies at every level of corporate and government leadership.

TK69's picture

The best solution would to do away with all government/employer sponsored retirement plans.  It would be more simpler and far better for the employee, if the money used to fund such plans went to the employee directly.  Then, he or she can find their own adviser and make their own pension plan based on their own needs.  This would not only simplify the process, but provide for better options, and it would keep public pensions from being used for political purposes.

RKDS's picture

And when public employees ask for a small raise to offset the retirement theft, watch the same jackasses who howled for self-managed savings go absolutely apopleptic.

gorillaonyourback's picture

there is no easy answers but i would say limit what the top executives make to 5 times the lowest paid worker, then saving for retirement wont mean keeping up with the jones.  in the 401k system you fall way behind in the defined benefit tax payers subsidize keepin up with the jones.  Sort of like an industrial cooperativa

RKDS's picture

Hell, even getting into double digit multiples would be better than what we have now.  Of course, you're overlooking one tiny immutable rule.  People with billions of dollars should never ever have to sacrifice anything; that's a job reserved solely for worthless labor who actually produces everything.

sun tzu's picture

So you're saying that pension plans can work as long as the government keeps raising taxes so that the pensions don't go broke. In that case, the 401k can work just fine too. When the employee doesn't have enough money in the 401k, just raise taxes and put the money in there. 


Pensions are great, as long as the company or government is solvent. The GM and Chrysler pensions would be broke now if Bush/Obama hadn't stolen $75 billion from the taxpayers to bail it out. All we need is a 401k union to lobby politicians to bail out anybody who is short on their 401k. Problem solved


Dirtt's picture

Excellent analysis.

Acting Man's picture

Your closing argument is a dog chasing after its tail.  Why does pension poverty exist, because of a constant erosion of purchasing power.  Why is purchasing power constantly eroding, because of monetary expansion (either through credit or monetary base).  Why is it necessary to constantly expand the money supply, because of future liabilities that have been promised to employees and various other patrons of governments.  Private unions have been forced to take DCs because they had a choice of less benefits or NO benefits (their company doesn't have a printing press).

I agree that 401(k) plans are a joke, but part of that is because they're designed to create and maintain wealth in markets that aren't being constantly manipulated and taken on roller coaster rides by the same governments scheming to keep their ponzi DBs and welfare programs afloat.  Dog chases tail, tail ends up being crusted in shit after he finally catches it.

CPL's picture


Either way the mechanisms offered to remove monetary supply under 401k's or RRSP's eventually have to come back into the system at some point.  When the money was given, the sad thing is the value of it was actually a lot higher.


Reason most people think of sticking their money into one is because governments want to avoid a glut of their own local currencies is to place the capital away somewhere.  In either case of DC or DB, you end up with inflation because of poor practices and that lazy shits contributing to them.


If people wanted a retirement plan to settle into then they should have built something productive.  Fuck, even a chip wagon Leo.  A chip wagon with a 20k investment and 6 hours a day has a better return than the return of any DC or DB I've known.  Tired of selling chips.  Cut hair and rent a barbers chair.  There's a return on investment.


I don't understand you jumping up and down on this subject at all Leo.  Seriously.  The money is gone and it's not coming back.  Ever.  If you are looking for a solution in a math puzzel, don't bother, the debt only balloons like a red giant without any safety net.  Want to make sure you have a reliable income in your 60's.  Two words.  Chip Wagon.  Might look like work, but that's because that is what it is.

No one here is royality, although by the straw men you roll in here repeatedly on the "deserving crowd" of their pensions.  Riddle me this, a person contributes around 300k in retirement funds over a lifetime to one of these junk bond plans and gets 5 million in benefits?  Who seriously dreams this shit up is amazing that anyone with a 6th grade math class couldn't see through it. 


Reggie got it right a couple of days ago.  You've been Bamboozled, hoodwinked, got ripped off.  Now you are waiting for the big phony check from Ed McManon.  You kidding me?  Come on, you're not a kid.  Santa, nor is Christ coming tommorrow to save you from the money lenders.  It's up to you to make the changes in your life to get over what ever train you threw yourself under to get this stuck.


Pensions are dead, been dead from the first contribution.  Want to know why Canada can't win a Stanley Cup?  Easy.  The kids are being raised to play the way their parents work, which is with zero effort, no ownership to themselves and fuck all in the sense of self. Although I'm going to guess it'll roll off your back, you'll fall into the "I'm a cripple mood" and start pointing at strawmen again.


Man up and start moving on something new. 

Toburk's picture

Technically the reason Canada can't win a Cup is that all the Canadians play for American teams (with their salaries subsidized by the profits of Canadian teams, who field American and European players) because the NHL wants to popularize hockey in the American market with winning teams.


But while that is a dubious business plan, it's far sounder than these poor saps waiting for the magic money fairy.

CPL's picture



If the Federal government announced that unicorns that shit skittles from their ass were running it all tommorrow, I'm pretty sure Leo would have an article on it.  I could honestly care less about pensions, it was noted as a bad idea on inception and every year since.

...RaNt On!

Like listening to some poor sap that SWEARS they seen bigfoot and builds a mini-media empire out of it.  It's plausible in terms of possibility, but get down to the hard math and science behind it...ummm. no.   The ability to deliver either options is tactically impossible in terms of demographics, money, math and crazy things like common sense.  Still kills me people still talk about "I'm getting a tax return on the money I put in my RRSP/401k" conversations.


So to straighten out that idea.  The government gives you back your own money on a wide tax bracket range to allow the money saved to lose it's value while the government prints more money on builtin inflation?  How does that work again?  Seriously?  The counter is "invest".  In a tax shelter?  How does that benefit anyone but the government creating the capital again?


Did the government magically say "shit, I better stop running nominal inflation because Citizen X contributed?".  No, the government says, "Print more to make up for the lack of cash to make up for the LESS THAN 0.4% cash supply sitting locked up in a tax shelter.  It's okay though, we'll be long gone."


So to all those dumb fuckers that fell for this tax avoidance scheme in the 80's.  Here's the crow pie.  the more people pull money from that "savings account" the less your money is worth, not because it's your money.  But because the demographics say 30% will pull money out and add back into the current money supply.  It's not so bad if was just a couple of thousand, but a HUGE cross section of society is depending on that money to not run out of insurance...then drugs...then house...then food.


Imagine that during the 80's most people were told to fear the scourge of coke, drugs, STD's.  Nobody told them if they played it safe they would only starve to death 30 years later or freeze to death, or die from a lack of drugs keeping their bodies working.  Somehow the idea of the light that burns twice as bright, burning half as long would appear to be the conservative choice now.

CPL's picture

I counter your Yes, with a staunch No. 

Any Maybe rebutals?

Thalamus's picture

Defined Benefit Plans are an absolute joke and don't work in the real world.  Sure the workers have a better retirement, but when the government that underwrites the defined benefit plan goes broke they'll have ZERO retirement.  Defined contribution plans are absolutely the way to go, adjusting automatically to good and bad returns, never underfunded, and you can get very low fees (we have them in our 401K).  

Nels's picture

'defined contribution plans' are NOT synonomous with 401K type plans.  If you die, your heirs get all the 401K, but nothing from the non-401K defined contribution plans.  Any death benefit from your employer is a separate policy.  Your co-worker is never benefited by money you chose to put in your 401K.

Defined contribution plans are just a way to make sure the company gets the benefit of inflation, and not the employee.  They can have the same under-funding problem as any other pension plan, or any other promise of far-future payment.

AN0NYM0US's picture

No, our sanitary engineers deserve the right to retire at 55 with  full medical and 60% of their final 3 years (including overtime) adjusted for inflation along with an accrued sick time allottment not greater than 12 months salary or $90,000, whichever is greater. To even suggest that hardwoking members of the public service be subjected to  DC   plans similar to what the majority of their private sector equivs are subject to is wrong.


and Leo pls... to cite Felix is like citing topcallingtroll or hamywanker