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2017-Understanding-Public-Pensions Understanding Public Pensions A Guide for Elected Officials April 2017 CENTER FOR STATE & LOCAL GOVERNMENT EXCELLENCE Acknowledgments Contents This guide was written by Elizabeth Kellar with contributions from Bonnie Faulk, Joshua Franzel, and Amber Snowden from the Center for State and Local Government Excellence, and Barrie Tabin Berger, AARP. Amy Mayers was the copy editor, and the guide was designed by Susan Spangler. We are grateful to the National Association of State Retirement Administrators (NASRA) for their guidance and review of this document. Introduction ..............................................1 Understanding Your Pension Plan ............2 Pension Plan Design .................................2 AARP is the nation’s largest nonprofit, nonpartisan Defined Benefit ......................................2 organization dedicated to empowering Americans 50 and older to choose how they live as they age. With Defined Contribution .............................3 nearly 38 million members and offices in every state, the District of Columbia, Puerto Rico, and the U.S. Hybrid ...................................................3 Virgin Islands, AARP works to strengthen communities and advocate for what matters most to families with a Characteristics of Public and focus on health security, financial stability and personal Private Retirement Plans ......................4 fulfillment. AARP also works for individuals in the marketplace by sparking new solutions and allowing carefully chosen, high-quality products and services Balancing Stakeholder Objectives ............4 to carry the AARP name. As a trusted source for news and information, AARP produces the world’s largest Public Pension Financing ..........................6 circulation publications, AARP The Magazine and AARP Bulletin. To learn more, visit www.aarp.org or follow @AARP and @AARPadvocates on social media. Funding Policy ...........................................7 Investments ...........................................8 Assumptions ..........................................8 Benefit Changes .....................................9 Strategies for Success .............................10 The Center for State and Local Government Excellence (SLGE) helps local and state governments become knowledgeable and competitive employers so they can attract and retain a talented and committed workforce. SLGE identifies leading practices and conducts research on competitive employment practices, workforce development, pensions, health care benefits, and financial planning. SLGE brings state and local leaders together with respected researchers. It features the latest research and news on health care, retirement benefits, recruitment, succession planning and workforce demographics. To learn more, visit www.slge.org or follow @4localgovtexcellence on Twitter. Understanding Public Pensions: A Guide for Elected Officials Introduction Public Plans — Quick Facts State and local pension plans are important in attracting and retaining well-qualified public Cover 14.7 million active (working) members employees. They help to facilitate the effective and efficient delivery of public services by serving Distribute $277.1 billion annually in benefits to as a workforce 9.9 million retirees management tool Not all changes and providing Hold $3.86 trillion in assets financial security are solutions. Financed by employer and employee contributions in retirement. As and investment earnings an elected official, it is important for you to understand how public Sources: Public Plans Data (PPD) and Federal Reserve Flow pension plans operate and the role they can play of Funds in meeting the needs of employees, employers, and taxpayers alike. A good starting point is to assess whether or not your pension plans are meeting and adequately funded so they can meet the goals their objectives. of all stakeholders. The purpose of this guide is to provide key facts You will quickly learn that since 2009 all states about public pension plans, including the elected have made modifications to their retirement plans official’s role in making sure they are well designed to help ensure their long-term sustainability. Every Retirement Plan Objectives Attract and Retain Enable Workers to Provide Keep Costs Employees Retire in Orderly Way Retirement Security Manageable 2 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS State and Local Defined Benefit Trust Assets Year-End, 1992-2016 (Trillions) 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 FISCAL YEAR Source: Federal Reserve Flow of Funds pension plan has a unique history, legal framework, Pension Plan Design and financial condition. As a result, there are no Retirement plan design can range from an employer one-size-fits-all solutions from state to state or even maintaining sole responsibility for providing a from plan to plan to ensure that pension plans are guaranteed lifetime benefit to employees bearing properly financed and effectively managed to pay the full responsibility to finance their own benefits for the long-term. retirement savings. In plans for state and local government workers, retirement plan design falls Finally, you will learn that not all changes are somewhere between those two extremes. solutions. Any modifications to a pension plan should be carefully considered to avoid unintended There are three major types of retirement plans consequences or costs. in the public sector: defined benefit, defined contribution, and hybrid plans. Understanding Your Pension Plan Defined Benefit As an elected official, you and your colleagues A defined benefit (DB) plan promises a specified have important decisions to make about your monthly benefit at retirement, usually based on government’s retirement plans. An important the employee’s length of service and salary. Most first step is to familiarize yourself with your state and local governments require both employers plan’s purpose and how its design and funding and employees to contribute to their defined mechanisms function. benefit pensions while they are working. Typically, Sound pension plan design and financing that these plans are funded through a combination of balance stakeholder objectives likely will produce employer contributions, employee contributions, a sustainable retirement system able to pay and earnings from investments. benefits for the long term with fewer unintended Public pension assets are held in a trust and or negative outcomes. invested in diversified portfolios to prefund the UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS 3 cost of pension benefits. These pooled assets are because public sector workers generally have professionally managed and provide economies of accepted more modest wages in exchange for more scale that lower fees and increase returns. Assets are retirement security. then paid out in monthly installments during an Retirement income also contributes to local and employee’s retired years, not as a lump sum. state economies as retirees spend their pension Typically, survivor and disability benefits are checks on goods and services where they live. part of the financing and design of the defined Defined benefit plans in both the public and benefit pension plan. Retirees also may be private sectors provide a reliable income for 24.3 eligible for cost-of-living adjustments, which may million Americans. Nationwide, over $1.2 trillion be capped or dependent on the pension plan in total economic output resulted from DB pension investment performance. expenditures in 2014. Reliable pension income is Defined benefit plans are the most prevalent especially important in stabilizing local economies 1 plan design in the public sector. The typical during economic downturns. defined benefit plan places some level of responsibility and risk on both the employer and Defined Contribution employee. This use of shared financing and shared A defined contribution (DC) plan is a retirement risk as part of plan design has grown in recent savings vehicle that accumulates savings based years as states have modified required employer on contributions to an employee’s individual and employee contributions, restructured benefits, retirement account. A DC plan does not promise a specific retirement benefit. In this plan design, or both. the employee, the employer, or both contribute Most state and local governments offer defined to the plan, often at a certain percentage of the benefit pension plans to their employees, in part employee’s salary. The employee will ultimately receive the balance in his or her account, which is based on contributions and any investment Defined Benefit Public Pension Plan earnings. Defined contribution plans typically Sources of Revenue 1986-2015 do not pool investments and employees are instead given a range of investment options they manage individually. While 401(k)s are most prevalent in the private sector, they are not common in the public sector, where 401(a), 403(b), and 457 DC plans are typically used instead. 26% Employer Although nearly all public employees have access 62% Contributions: to a DC plan as a supplemental savings plan, part $1.8 trillion Investment of a hybrid plan, or as an alternative to a defined Earnings: benefit plan, only a handful of states and the $4.3 trillion District of Columbia provide a defined contribution 12% plan as their employees’ only retirement plan option. Employee Contributions: In a defined contribution plan employees assume $805 billion
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