The Downside of Choice
Who doesn’t love choice? Chocolate or vanilla? Cheese or pepperoni? Boutique fitness studios have popped up everywhere so no matter what your preferred workout, you can have it. Lawmakers in some states like Michigan, Florida, Pennsylvania, and Indiana have co-opted our national love of choice as their preferred method to attack retirement security. Although a recent Gallup poll found that 51% of Americans would leave their current job for a position that offered a defined benefit pension, these politicians are pushing for choices that no one wants.
This year, Indiana decided its teachers need a “choice” between the security of a pension and the insecurity of a 401(k). Florida, a state that already offered a choice between a pension and a 401(k), mandated that any new employee who does not proactively select a plan will default into the inadequate 401(k) plan. Pennsylvania, while doing nothing to address its unfunded liabilities, created three new options for its state employees and teachers. Three options that won’t save the state money and that will provide worse retirement benefits. But at least employees get a choice, right?
We might then assume that police officers, firefighters, teachers, and other public employees are ecstatic when legislators give them a choice in retirement plans! However, the data tells a different story. The National Institute for Retirement Security studied eight states that offer workers a choice between a pension or a 401(k)-style plan. In six of those states, eighty percent or more chose the defined benefit pension. In the Ohio and North Dakota public employee pension plans, 95% and 98% of workers, respectively, chose the pension plan. Even when states default employees into a 401(k), as Florida will now do, most employees still actively elect to join the pension plan.
Choice also has negative consequences for the pension system and the state. First, it threatens the funding stability of the pension plan. Pensions work well with a continuous cycle of new employees beginning their careers and older employees beginning their retirement. The system pays benefits to retirees, new employees contribute to the system, the system begins earning returns for their eventual retirement, and the cycle continues. We’re all in this together.
401(k)s siphon off some contributions and this starves the system of returns (which have been as high as eleven and twelve percent this year). Second, the 401(k) is a disincentive to dedicate a career to public service. This costs the city or state when a firefighter or police officer leaves after being trained. Or means that teachers never reach their peak after years of on-the-job experience. Pensions were designed to help manage the workforce and the 401(k) option undermines that.
Pensions are the gold standard in retirement. Workers pool together their own contributions plus employer contributions into an account that is invested by financial professionals. At retirement, a worker receives a defined monthly benefit, for life, based on a calculation of their total years worked, final salary, and a multiplier. What that means in reality is that a worker knows exactly what they can expect each month in retirement — allowing them to plan to cover their basic expenses and perhaps even travel or support their grandkids’ education.
At one time, 88% of workers in the private sector were offered a pension (if their employer provided any retirement plan at all). Then, driven by greed and the bottom line, corporations slowly moved away from pensions in favor of the 401(k). What may have worked for corporate greed has been a failure for the majority of American families. The median 401(k) balance is just $18,000. And should your retirement date coincide with a recession, you could lose much of your savings right when you need it most. The collective risk-sharing of a pension doesn’t exist for 401(k) savers.
According to Gallup, workers everywhere recognize that a workplace with a pension is a good place to be. Policymakers should recognize that too and protect and expand defined benefit pensions.
Bailey Childers is the Executive Director of the National Public Pension Coalition. Follow her on twitter @baileykchilders