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News from EPI Hybrid and Cash-Balance Pension Plans Are All Risk, No Reward

The debate over retirement over the last 30 years has largely focused on two choices—traditional, defined-benefit pensions and 401(k)-style, defined-contribution plans. Recently however, advocates of major changes to state and municipal pension plans have called for the adoption of “hybrid” plans, such as cash balance plans, that combine elements of 401(k)-style defined-contribution plans with traditional defined-benefit plans. Defined-contribution and hybrid plans can be collectively referred to as “account-type” plans.

In Will Switching Government Workers to Account-type Plans Save Taxpayers Money?, EPI economist Monique Morrissey outlines the issues associated with hybrid, cash balance, and other account-type plans. Notably, Morrissey argues, these plans can create workforce management issues and increase retirement insecurity, without saving states any money.

“Cash balance plans are touted as the best of both worlds, but in actuality the reverse is true,” said Morrissey. “They’re less predictable and transparent than traditional pensions, and they make it harder for workers to anticipate what they will get at retirement, without reducing risks for taxpayers. The cash balance plans introduced in recent years are more expensive than proponents claimed. Some have even increased turnover by giving more valuable benefits to young workers who leave their jobs.”

In terms of overall cost, defined-benefit plans are more efficient than defined-contribution and most hybrid plans, due to economies of scale, risk pooling, and other factors. States that have switched to account-type plans have not saved money—except to the extent that they have simply cut benefits or required workers to contribute more.

With regard to workforce management, many cash balance plans provide the biggest benefits to young workers and workers who leave their jobs—promoting high turnover in public-sector jobs that require a high level of skill and experience. While a well-designed hybrid plan could theoretically help younger workers without undermining the retirement security of midcareer and older workers, none of the plans offered in the current political climate has done so.

Moreover, public-sector workers have consistently shown a strong preference for easy-to-understand and secure retirement benefits, and are willing to pay for these benefits directly (through employee contributions) and indirectly (by accepting lower salaries). Thus, a shift to account-type plans is likely to harm recruitment and retention, or require increases in other forms of compensation.

Account-type plans also increase retirement insecurity, by making it difficult for workers to anticipate their retirement income and encouraging workers to cash out their plans in a lump sum.

Despite the evidence, several states and municipalities are considering a switch to account-type plans. Notably, New Jersey Governor Chris Christie has made a high profile pitch for a cash balance plan, and Nevada legislators are considering a change to a hybrid model. Meanwhile, legislators have adopted these types of systems in places like Kentucky, Rhode Island, and Kansas.

“Governor Christie embodies what is wrong with the pension debate today. Here is a politician who irresponsibly failed to make the government’s promised pension contributions, and who is now trying to change the subject by introducing a new type of plan that will help neither taxpayers nor workers,” said Morrissey.

The most generous and secure cash balance plans may be a good compromise in some circumstances, but their advantages should not be overstated, nor should the disadvantages of traditional pensions be exaggerated. Traditional pensions help public employers recruit career-minded workers and facilitate orderly retirement. Rather than attacking the pension benefits of career public employees, reformers should focus on expanding Social Security, the most portable and secure retirement benefit of all.