By: Rep. Hubert Collins
October 1, 2012
As it stands now, the Kentucky General Assembly has four plan options to consider as it looks at restructuring public employee pensions in the Commonwealth during the upcoming 2013 Regular Session.
Experts from the Pew Center on the States and the John and Laura Arnold Foundation laid out each of the four options—-a defined benefit plan (the current plan used by Kentucky Retirement Systems), a defined contribution plan, a cash balance plan, and a hybrid plan—for the Kentucky Public Pensions Task Force in mid Sept. and told task force members the pros and cons of each. I want to share with you what the task force learned from the experts.
(The following information is for nonhazardous workers only, although information is available for employees in state and county hazardous plans. Each plan would cost the same as the current state plan and keep employee contributions the same.):
Defined Benefit Plan: In the defined benefit plan, both employee and employer (in this case, the state or local government) pay into the employee’s retirement. Workers contribute five percent, while the employer pays around four percent. That money is then invested and benefits are paid out at retirement. The experts from the Pew Center and Arnold Foundation said that, while there is little risk shared by workers in a defined benefit plan, there is no sharing in increased investment returns like there would be in a defined contribution plan. Also, defined benefit plans outpace other plans the longer an employee works, but offer little benefit compared to a defined contribution plan at the end of the worker’s career, say the experts. System costs vary substantially with this kind of plan.
Defined Contribution Plan: A defined contribution plan is a retirement plan in which individual accounts are set up for employees and retiree benefits are based on amounts credited to those accounts (through employer contributions and, if applicable, employee contributions), plus any investment earnings. Only employer contributions are guaranteed, not benefits. Benefits can fluctuate on the basis of investment earnings. The most common type of defined contribution plan is a savings and thrift plan in which the worker commits to an individual account a predetermined portion of his or her earnings (usually pretax), all or part of which is matched by the employer. In a defined contribution plan, say the experts, the employee bears any extra cost although “assets increase dramatically while those in the other two plans get a lesser gain.”
Cash Balance Plan: A cash balance plan offers an individual retirement account for each worker. For nonhazardous employees, nine percent of employee pay would be deposited into an account annually (five percent from the worker, four percent from the employer, just like under the current defined benefit plan in place for Kentucky public employees). Money in the cash balance plan accounts is invested, with the employer providing a minimum return guarantee. Workers can use the money in their account to purchase an annuity, which secures a stream of payments to be made to an individual during his or her retirement years. The experts said a cash balance plan offers employees “two of the key protections commonly associated with a defined benefit plan: A guarantee against investment risk, and protection against outliving one’s retirement assets.”
Hybrid Plan: The hybrid plan includes a small traditional pension plan and individual retirement account for employees. The retirement benefit multiplier on such plans is one percent, meaning that for 20 years of work, an employee is guaranteed 20 percent of final average pay. Under a hybrid plan, the experts say retirement wealth grows slowly, at first, then accelerates like it does under a defined benefit plan. A worker’s pension loss is more even than under a traditional pension, however, due to the individual retirement account.
Which plan makes the most sense for Kentucky? That depends on how lawmakers answer three specific questions, according to the experts from Pew Center and the Arnold Foundation. And those questions are: 1. How should workers earn benefits over time; should those benefits spike late-career or be earned more smoothly throughout their career? 2. How should risk be allocated? (Should taxpayers assume it all, should it all go to the worker, or should it be shared?) 3. What will best recruit workers (considering that retirement is part of compensation)?
The Public Pensions Task Force is taking this and all testimony brought before the task force into consideration as it prepares to issue final findings and recommendations regarding the public pension systems to the Legislative Research Commission by Dec. 7. Proposed legislative changes might also be presented by the task force by that date, in order to give lawmakers a chance to consider the proposals early in the 2013 Regular Session. I will keep you posted on any developments.
Don’t forget that open enrollment in the Kentucky Employees’ Health Plan (KEHP) for 2013 will be held Oct. 8-Oct. 26. It will be a “passive open enrollment,” meaning your insurance elections made for 2012 will automatically renew in January if you don’t take any action. There are a few instances in which you must take action, and we will go over those next week.
Talk to you then.