NCPA - National Center for Policy Analysis

Texas Could Join Other States With Defined Contribution Pensions

May 4, 1999

Following a trend among private sector employers, states are shifting public employee pensions toward "defined contribution" plans instead of the traditional "defined benefit" plans. Making the shift in Texas would benefit both taxpayers and employees, says a new study.

Under defined benefit plans, the employer promises a specific retirement benefit and invests funds in a common pool to finance them. Under a defined contribution plan, the employer and employee contribute a specified amount into an investment account (similar to a 401K) for the worker. These funds, plus accumulated returns over the years, finance retirement benefits.

In Texas, the state and its employees each pay 6 percent of wages into defined benefit plans -- with retirement income based on the employee's highest average salary and length of service. Yet, with the same employer match, researchers say a defined contribution plan would provide workers a higher monthly benefit. For example,

  • A worker with 40 years' service and $40,000 annual salary will receive $32,000 to $36,000 in benefits under Texas' defined benefit plan -- but $46,799 a year under a defined contribution plan.
  • A worker with 10 years' service and $40,000 annual salary will receive $8,000 to $9,000 under the current plan -- but $24,797 yearly under a defined contribution plan.
  • Thus, a worker with 40 years' service would receive 117 percent of pay in retirement under a defined contribution plan, instead of 80 percent to 90 percent of pay.
  • And a worker with 10 years' service would receive 62 percent of pay, instead of just 20 percent to 22.5 percent.

Furthermore, whereas the state now assumes unknown future liabilities, under a defined contribution plan its financial obligation is known and limited to its contribution. Workers would also benefit from the individual ownership, immediate vesting and portability of a defined contribution plan.

Ten states have adopted defined contribution reforms for at least a portion of their workers; reform legislation is now pending in six states; and formal legislative studies are underway in 12 others.

Source: Peter J. Ferrara, "Pension Liberation for Texas," April 1999, Texas Public Policy Foundation, P.O. Box 40519, San Antonio, Texas 78229, (210) 614-0080.

 

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