States’ Pension Reform Reduced Potential Retirement Income

According to a report from the Center for State and Local Government Excellence and the National Association of State Retirement Administrators, calculations of the projected initial retirement benefit of state and local employees, before and after recent modifications were made to pension design and financing, shows reductions ranging from less than 1% (for new state employees in Colorado) to 20% (Alabama). The average benefit for the 24 states that changed variables in their benefit calculation equaled approximately 92.5% of the benefit produced under the prior conditions. In other words, the average benefit change in this analysis was a decrease of 7.5%.

The report concludes that given the benefit reductions, aside from Social Security (if the employee is eligible), public employees will need to take advantage of supplemental savings vehicles to maintain similar salary replacement rates in retirement, pre and post reform. In some states, employees will need to save more than $100,000 on their own.

The report notes that as a result, many plan administrators are providing enhanced financial education and offering and promoting supplemental savings vehicles.

In addition, according to the report, in the states analyzed, reforms to retirement eligibility and employee contributions mean the average new employee will have to work approximately two years, eight months longer (holding all other variables constant) to reach the benefit level available to employees hired previously.

In some states, a hybrid defined benefit/defined contribution plan was set up as part of the reform. The researchers also analyzed the effects of these plans. In two of the five states studied, the hybrid plan may produce a diminished benefit when compared to the original defined benefit plan. In three of the five states, the hybrid plan may yield a benefit that is greater than the original defined benefit plan.

In the cases where the hybrid plan yields an enhanced benefit, the excess is made up exclusively of annuitized defined contribution earnings over time, the report says.

The full report, which includes methodologies for the analyses, can be downloaded from here.