By REP. KEVIN MCCABE
If there was any real data from the employers who would use a state defined benefits (pension) plan that would indicate that such a plan would help keep public employees from leaving, or if these defined benefits plans were not such a dud, I’d be all for it. Let me explain.
In a defined benefit plan, the risk is primarily assumed by the employer (or the government, in the case of public sector pensions) rather than the individual retiree. This means that to limit risk, the plan would necessarily be in less risky (read less profitable) investments so the plan would remain solvent. This is the overarching goal of the plan.
Here is how the risk is distributed in a defined benefit plan
- The employer (government) assumes the primary risk. The employee typically gives up dollars per hour in contract negotiations to help the employer fund this plan on the front end. Employees are also often asked to contribute a certain percentage of wages to this plan as well as pay for the ability to transfer the remainder of the plan to a spouse upon the retiree’s death.
- Investment risk. The employer is responsible for ensuring that the pension fund has enough assets to pay future benefits. If investment returns fall short, the employer must make up the difference.
- Longevity Risk. If retirees live longer than expected, the plan must continue payments beyond what was originally projected with taxpayers picking up the loss.
- Inflation Risk (sometimes shared). Some DB plans include cost-of-living adjustments (COLAs), meaning the employer bears the burden of rising expenses over time.
Employees (Retirees) have limited risk, but some exists
- Insolvency risk. If the employer (or government entity) mismanages the pension fund, there’s a risk of benefit cuts. Private pensions in the US are partially insured by the Pension Benefit Guaranty Corporation, but public pensions depend on taxpayers.
- Policy and funding changes. Governments or corporations can modify future benefits (e.g., increasing retirement age, reducing COLAs) for active workers, though not typically for already-retired employees.
- Taxpayers risk (for public pensions). In the case of government pensions, if there’s a shortfall, it’s ultimately taxpayers who cover the gap through increased taxes or redirected public funds. This has been a major issue in states with underfunded pension systems.
- 401(k) plans shift risk (and rewards) to the individual. A 401(k), IRA, or defined contribution plan shifts investment and longevity risk to the retiree. If market returns are poor, the individual bears the losses. However, they also have more control over their investments and withdrawals and are able to invest in higher yield stocks earlier in their career. Typically, in a 401(k), a decent manager would not be so risk-averse in the early stages of an employees building of his retirement plan as a DB plan administrator must be to protect the plan itself.
In short, defined benefit plans protect retirees but put financial pressure on the employer (taxpayers) whereas 401(k) plans give individuals control but also expose them to market risks.
Historically, whether it’s better to assume risk and control your own retirement savings or rely on a secure pension depends on several factors, including market performance, personal financial habits and age, as well as the stability of pension funds and the underlying (funding) employer. Defined benefit funds are also subject to the vagaries of contract negotiations for union members and the fund manager that the employer contracts with.
Let’s break it down further
- Investment growth, 401(k) vs. Pension Returns. A well-managed 401(k) can outperform a pension if the individual starts early, invests wisely, takes advantage of market growth, and manages withdrawals efficiently.
- Not all individuals are skilled investors, however, and many people fail to save enough, invest too conservatively, or panic-sell during downturns. It pays to have a professional fund manager to help with your investment decisions.
- Defined benefit pensions typically assume a lower but stable return (often ~6-7%) because they invest heavily in bonds and diversified assets for long-term stability and to protect the corpus of the fund as they must fulfill the guaranteed benefit to retirees.
- Historically US stock markets have averaged ~10% annual returns over the long term, meaning disciplined 401(k) investors often accumulate more wealth.
Risk assessments. Guaranteed Income vs. Market Volatility
- A defined benefit pension eliminates longevity risk (outliving savings) and market risk (bad investments).
- A 401(k) requires personal responsibility, and retirees must manage their own withdrawals carefully to avoid running out of money. Again a professional fund manager is helpful.
- Market downturns (e.g., 2008 financial crisis) hit 401(k) holders hard, while pensioners continued receiving their checks.
- Historically 401(k) participants can build more wealth, but many mismanage their funds. And, while pensions offer security, they limit flexibility, and if underfunded (like some state pensions [SUCH AS ALASKA]), there’s risk of benefit cuts.
- The decline of pensions and rise of 401(k)s. In recent years, private-sector pensions have nearly disappeared because they are expensive for employers and unpredictable in cost. Congress also allowed the money that was supposed to be set aside for pensions to be used for operating capital. This resulted in some spectacular losses for retirees when the employer they retired from went bankrupt. So most employers now offer 401(k) plans instead, shifting risk to workers but allowing them to build personal wealth often even offering a professional fund manager with a wide range of options for the employee. While public sector jobs still offer pensions, many are underfunded and could see future changes including bankruptcy of the State or entity that carries the fund.
So which has historically been better? For disciplined investors, a 401(k) will almost certainly outperform a pension if invested wisely and withdrawn responsibly. For risk-averse individuals: A defined benefit pension is better because it guarantees income for life without requiring investment skill.
The transferability question
Heirs cannot inherit the wealth accumulated (the money the employee pays in), or loses in contract negotiations, in a defined benefit plan in the same way they could inherit a 401(k) or other defined contribution accounts. Here’s why:
- A defined benefit pension provides a guaranteed income for life but does not function like a personal investment account. The employee or retiree does not “own” the wealth accumulated in the plan. Instead, the retiree receives a monthly benefit based on salary history and years of service, but there is no individual account balance to pass down.
- Survivor benefits (limited inheritance). Some defined benefits plans offer a survivor benefit option, meaning a spouse (or in rare cases, a dependent child) can continue receiving payments after the retiree dies. This often requires choosing a reduced pension payout in retirement to cover a surviving spouse.
- Once both the retiree and eligible survivor die, payments stop, and nothing is left to pass to heirs.
How a 401(k) or IRA differs from a defined benefits plan
- 401(k)s and IRAs are personal “assets” beneficiaries can inherit any remaining balance.
- A retiree could pass down hundreds of thousands or even millions to his or her heirs in a 401(k), whereas a defined benefits pension ends when the beneficiary dies (except for pre-arranged survivor benefits).
What If You Die Before Retirement?
Some pensions have a lump-sum death benefit for heirs if the worker dies before retirement. However, this is usually a small payout compared to the total contributions made over time (the “wealth” invested in the fund by the worker).
The bottom line is that a 401(k) or IRA allows for full wealth transfer to heirs, while a defined benefits pension provides lifelong income but generally does not create generational wealth. If leaving money to children is a priority, a 401(k), IRA, or personal investments offer better inheritance potential.
Rep. Kevin McCabe is a legislator from Big Lake, Alaska.
The legislators pushing the defined benefits plan all know what is said here is true. I’m wondering what benefits a legislator gets by lying to the public.
Yes, please don’t do defined benefit. I want defined contributions.
Also, reverse inflation makes the pension a bad idea. Young workers that earn defined benefits, find the benefit earned those early years isn’t that great. i.e . Gaining a $150/mn benfit at age 25 really won’t be worth that much at age 65.
Good discussion. It would be valuable to add the State’s supplemental benefits system (SBS) and deferred compensation plans. Because these two can add up to a million dollars upon retirement for a 30 year employee. Cash.
But wait, there’s more. An employee can also invest cash into a savings account with a statutorilly fixed 4.5 percent interest rate. Wow. This high rate can outbalance the need to choose “stable value” low interest bonds or other investments in their 401k.
The State also offers life insurance, but few know of or choose the plan that they can take with them upon retirement.
The sad part of this discussion is how few State employees take advantage of the investment opportunities the State offers. And how little the ($70/month) unions help their members learn about and make wise choices for retirement. Once retired, of course, employees cease paying union dues and aren’t members.
I fear too many govt employees live paycheck to paycheck with no financial view to their future. One supposes they can always serve as Walmart door greeters upon retirement? It is their choice.
All of this is true, and this is a very well written article. However, defined benefit plans still remain far more popular with employees than defined contribution plans because most people are afraid of managing their own investments, knowing that they are not competent in this regard. They are mainly concerned with running out of money in retirement as opposed to having money to pass on to their heirs.
Furthermore, if a pension plan runs short, there remains the option for the corporation to use other funds to support it, or as stated here, it can be supplanted by the PBGC. When an individual runs short on money in retirement, he or she generally has no one or nothing to fall back on, aside from going back to work if possible or perhaps taking a reverse mortgage.
As I noted in previous comments on this website, the shift from defined benefit to defined contribution was driven by Wall Street and not Main Street. Almost to a person, I’ll bet if readers and commenters were honest, they would say that they still preferred a defined benefit plan.
Oh, and I guess I must add that it’s easy to see why those without defined benefit plans can therefore be very jealous of those that do.
You Just stereo-typed those who want/choose defined benefits (teachers/school administrators). As afraid, incompetent, and uneducated in average personal finances (Frist paragraph).
About your last paragraph. I don’t know why I would be jealous of those with define benefits (DB). Those with or want to have DB, have no generational wealth to pass on. They don’t know how to use their money to make money, and are uneducated in finances.
As they live from pay check to pay check, by their daily financial choices.
Though, if you are inferring to me as jealous of DB is because, I rely on government to take money from all residents and redistribute them to those who are afraid, are not good with their personal finances, and are uneducated how to use money. I guess, I am not the good socialist you want, all of us to be.
I didn’t stereotype – I was referring to the statistical majority, which is valid. Of course there are exceptions. But just look at companies like Boeing, where thousands of their folks just went on strike to get their old pension system back.
Or, maybe offer both. But don’t offload all of the risk onto employees who don’t want to accept it. Better outcomes happen when people specialize. And that meant a rivet installer is very good at that, while a pension manager is equally good at that.
Ask around to all of the MAGA voters who have come to feel disadvantaged over time. They have seen their wages cut, their benefits cut, and their fixed pensions cut. They feel cheated with 401Ks or often nothing at all, all in the financial interest of Wall Street and their employers. These are the types of things that have driven them into the arms of Trump and MAGA. But soon they will learn that what they thought was their salvation will indeed turn out to be their further undoing.
WTD your bias colors your assessment.
You assume that the ire of the private sector has to do with their jealousy for government workers pensions. I think that really is not the case. The most hated sentence in the private sector is:
“Good enough for government work” meaning that the citizens are supposed to accept mediocre service from our government, while those providing that service get to spend hard earned private sector tax dollars on regulations and rules, making doing business more difficult or fritter it away on the latest fad. The ire with pension plans are simply a symptom of guaranteed taxpayer funded security regardless of performance. It should be pointed out that pension plans tie an employee to that particular employer.
In the case of Boeing pensions, if they go bankrupt all these employees would loose everything, as there is no taxpayer to bail them out(a potential scenario with all their recent technical issues and the potential for shuttering their space program). Yet with a 401k that is diversely invested they can manage to salvage some of their retirement.
In my opinion this push for pensions is not to benefit the workers, but their unions administering their particular plan. We know that unions aren’t the best money managers either. I’d take a Wall Street guy over them any day.
The freedom of a personal retirement plan (be it in real estate, investments or else) allows people to have control over their lives and pass those earning to their descendants (or blow it all on a trip around the world-their choice)
I worked for the state for ten years and received defined contribution. I am very glad I got my 401k and not a pension. The people of Alaska and I had our accounts squared away the day I left. They owe me nothing and I owe them nothing. I can do anything I want with my money.
” As I noted in previous comments on this website, the shift from defined benefit to defined contribution was driven by Wall Street and not Main Street.”
I disagree.
Defined benefits made sense decades ago when most individuals stuck with one employer. These days there is great movement in the jobs market and it is not unusual for individuals to have many jobs with multiple employers over a life time. A 401k can be moved from one employer to another or be rolled over into an IRA that belongs to the individual. Pensions do not work that way. You leave early you loose it all and you have no way to streamline withdrawals, but have to take the amount determined by the pension fund. With an investment account after you reach 59.5 you can withdraw any amount. The power should stay with the individual employee to determine how they want to structure their retirement and not be beholden to unions or their employer.
beware the enslavement of wearing those golden handcuffs
Kevin McCabe, king of the RINOs, is responsible for getting David Eastman replaced with a liberal Republican.
David Eastman might not have caucused with the Democrats but he was often working with them and against his fellow Republicans, numerous Democrat led caucuses over his years in the legislature were in the majority only because of him. I can think of no greater harm to the conservative cause in the last decade than David Eastman serving as a legislator for (and nullifying) a conservative district, while delivering Democrats majority after majority. If he were still in the House the Republican minority would, no doubt, be smaller than it is now.
McCabe may or may not be a RINO, but at least he doesn’t work with Democrats against conservative or Republican causes the way Eastman did. In the same token, Eastman’s replacement has already done far, far better than Eastman ever did simply by not serving Democrats in the way Eastman did at virtually every turn.
No employee pensions paid by this state. We are broke!
Much of the cost is the retirement terms. As we know, private sector employees retire at much later ages on average, particularly when police and fire employees are considered. Also, the retirement rules encourage stacking up overtime to enable them to earn as much or more in retirement than while employed. This is why we see police officers making $250,000 a year. So they retire earlier, with a guaranteed take, at a much higher level of payment, at a fixed rate regardless of economy conditions affecting people paying for it.
Welcome to the servant class folks. We also see the forced slavery in the valley where teachers are guaranteed a 4.5% raise while those in the private sector do not. Slavery.
A few suggestions:
Extend retirement ages.
Do not allow the common practice of overtime stacking. We are paying for many retirees, too many, per working employee. We do not have the money for this.
Retirement calculated at average inflation rate adjustment if the people paying taxes.
The ability to leave the a defined contribution plan to heirs is a huge advantage.
as well as the portability which prevents members from becoming beholden to their administrators
Thanks for your hard work on this important legislation
As a person who has a private sector defined benefit plan in addition to a Roth 401k, traditional 401k, and various rollover accounts as well as brokerage accounts; I’d prefer to not have the defined benefit plan. I could get a much better rate of return and have a much better retirement if I wasn’t hamstrung by an approach to investing that limits growth to an absurd extent. With a defined benefit plan when I die my money is either rolled back into the plan or I would have had to take a diminished return to have my spouse continue to receive a smaller payout than I would have otherwise received. With a 401k the funds that I saved and grew belong to my estate, other than any appropriate taxes…because the government always gets their share.
Most retirement funds (groups or individuals) would be better off by simply investing in an S&P 500 index fund. Let’s face the facts if or when the wheels fall off it won’t matter if you are invested in gold and silver, bonds, value or growth funds, or the most speculative stock…we are all betting on the wheels staying in place, even if they get wobbly from time to time.
“What’s the fuss!” Are you insane? Alaska already has an existing unfunded liability of $7,000,000,000 that is not going away and clowns like McCabe apparently are ready to risk more to appease public employees who believe no risk is too great for the rest of us citizens to assume so that they can have a gold plated defined benefit retirement plan, a kind that is now exceedingly rare in the private sector.
Why should we worry? McCabe tells us “ In a defined benefit plan, the risk is primarily assumed by the employer (or the government, in the case of public sector pensions) rather than the individual retiree. This means that to limit risk, the plan would necessarily be in less risky (read less profitable) investments so the plan would remain solvent.”
Of course the opposite is true. Underfunded DB plans all across the country have been in fact drawn to riskier investments seeking outsized returns to reduce the pain of funding these plans deficits. Who is on the hook? We all are and plan insolvency would create a direct claim on the Permanent Fund. Do you really want public employees to have a first lien on the fund which will pay them their benefits at your expense?
Why are so many public plans underfunded? Because legislators always overestimate LNG term investment returns to understate current costs. It lets them spend more today. If the public understood this part of the game, they would be lynching legislators.
Right now Alaska has the largest unfunded public pension liability in the nation. It’s roughly $46,000 per person. What has McCabe done to address this? He has been throwing gas in the fire.
You should actually read the article. McCabe has written a couple of pieces at MRA in opposition to any DB program. He is often quoted from floor speeches against DB. McCabe was largely responsible for the contentious committee hearings against Josephsons HB22, the last defined benefit bill, at the beginning of last session. He was part of the House Majority that did not let HB22 or the Senate Bill out of committee. The results of that were Kopp running against, and winning against, Craig Johnson. So the real question, after you read the article again, is what are YOU doing to address this? Have you at least written or called your legislator? Have you informed your union membership if you have one? Have you talked to your friends who are state or borough employees?
Two corrections:
1) LNG term means long. (My iPad auto correct at work.)
2) Alaska does not have the largest unfunded public pension liability, it has the largest per capita unfunded public pension liability. Each Alaskan is presently on the hook for $46k, money that must come out of the State’s coffers or stream of revenue to make the existing TRS and PERS whole.
Several things going unsaid here.
Blue collar does not mandate you don’t know how to manage money. People don’t know how to manage their money because they don’t try. 90% of what you need to know can be read out of about 3 books. Money management is taught early and goes hand in had with something called delayed gratification. Something a lot of Americans are really bad at.
I have spent a life time managing my own assets and you make mistakes but whom would you rather have make those mistakes you or your paid investment advisor, most of whom can’t manage to keep up with the average market returns over years and then have you paying a escalating fee! get as much defined benefit as you can but put the larger effort into getting a matching 401K. I did and never looked back. Here is my two cents for free. If you are under 30 go all in 100% to Vanguard Total stock market ETF put it on auto deposit to 15% of your income and forget about it. Over 45, 75%. Look at it enough to know it’s growing and not more.
I do not feel that any elected/appointed officials should be allowed retirement benefits. They should be allowed health insurance during their time in office, but these should cease once that they have completed their term in office. They should be considered as contract workers, and not as employees of the State.
Big part of why we are a training ground for law enforcement is that they can get trained in AK and then go earn a defined benefit package damn near anywhere else in the US. We’ve got stacks of unfilled positions, so are always eager to train new troopers/cops, but they leave as fast or faster than we can train them. I am less confident than most commenters on this site that the status quo approach to funding law enforcement maximizes either our public safety nor long term fiscal stability; rather our present approach feels pennywise and pound foolish.
There is no proof to what you said. In fact the troopers themselves will tell you, based on their exit surveys, that trained State Troopers are not leaving because of a lack of a defined benefit program. There is no disputing this. And, in fact, the troopers, as reported today in House Finance, are better staffed than they have been in decades and the VPSO program is fully staffed. I urge you to do your own research and not rely on the soundbytes that come from those who have an agenda (UNION Leadership).
‘https://www.alaskasnewssource.com/2022/02/04/facing-retention-crisis-alaska-legislature-considers-more-generous-first-responder-retirement-scheme/
48 of the 50 states have defined benefit for public safety employees. Are they all just socialists?
You answered your own question ” 48 of the 50 states have defined benefit for PUBLIC SAFETY EMPLOYEES.”
Our legislators trot out the troopers and fire fighters the same way the ASD board trots out having to fire teachers when they can’t or more likely won’t budget properly. This isn’t about “just troopers” this is about EVERY state employee getting a gold plated retirement packet and the taxpayers footing the bill in perpetuity.
a pension is not the only way to retain employees and prevent the state from becoming a costly training ground
Mr. McCabe and other commenters leave out a key point. The vast majority of employees in this country have a DB retirement in the form of Social Security. And to be sure, no one wants to live on just that (hence the need for IRA’s, investments, savings, etc) in addition, but it has a key benefit. If you something bad happens to you that uses all your money you still get SOMETHING every month. Go to the store and buy the big jar of peanut butter and a box of powdered milk and try to live another month.
For some percentage of follks that work a lifetime for the SoA, they will become destitute. It may be an illness of their own or their spouse or child, or some calamity, or some remarkably stupid decision. They will have no income and be at an advanced age with little opportunity for employment. They become wards of the State or their children, if they have them. It is very anti-family.
A real retirement has balance – a number of different assets. State of Alaska employees are missing a key one, made up for by the DB retirement program but totally missing for everyone hired since July of 2006.
People that are making a choice about where to live will do the math and move away, at substantial expense to us, people that live in Alaska. We are not competitive.
You forget that fact that SSA is a program that involuntarily removes a bunch of money from my paycheck every month. It is not, in fact, even close to a DB program. The money I paid in to SSA will most likely never equal the money I get out of it (due to increased retirement age) before I die. SSA benefits were put in place, and the retiment age was put in place, at a time when the retiree was not expected to live even a few years after retirement. It is wildly different from a DB program funded by the state and invested in money making instruments. SSA is not invested anywhere. What you are suggesting is not surprising coming from a big-government-will-take-care-of-all mentality. The suggestion that workers are incapable of taking care of their retirement is non-sensical. And the data is not there to suggest what you are saying is true.
“For some percentage of folks that work a lifetime for the SoA, they will become destitute. It may be an illness of their own or their spouse or child, or some calamity, or some remarkably stupid decision. They will have no income and be at an advanced age with little opportunity for employment. They become wards of the State or their children, if they have them. It is very anti-family.”
Mr. Holleman the same can be said for their private sector counterparts, yet you seem quite comfortable burdening them with the ever increasing responsibility of providing for their government brethren.
Shouldn’t these former employees of the state also receive SS and be able to buy powdered milk, peanut butter and bread? If they are not eligible for SS then they contributed to a pension plan of some sort making your point moot.
Why is caring for your aging parents “anti-family”?? Isn’t that what families do, care for each other?
SS is not comparable to a DB plan you are proposing, as it is a mandatory federal program, designed to supplement, not replace. Your DB plan to my understanding also includes medical and acts as a FULL replacement of work income.
Lastly in a state of less than a million residents the financial burden of such a plan will over time consume the vast majority of available funds and severely limit the state’s ability to meet its constitutional obligations to maintain infrastructure, law enforcement and other needs.
State of Alaska employees are capable individuals (otherwise they should not work for the state) and should be able to manage their own retirement plans. Expand the 401k options, instead of this insane and costly DB scheme unless your overall goal is to eventually get your hands on the corpus of the Permanent Fund.
A lot of people simply cannot manage financial investments. Many will raid their 401k balances early in life, leaving them still in need of bailouts from the rest of us later in life. So simply saying “too bad” doesn’t work, and we all know it.
A hybrid approach would be best. Bare minimum defined benefits with the remainder in a defined contribution plan.
35yrs ago my wife quit working for the State of Alaska after only 10.5yrs at $12.78hr tier-1. I never even worked as a state employee. Today we both still have 100% gold-plated medical/dental/vision care…. plus fully-paid long-term care, until we die. I am always amazed at how profoundly stupid the citizens of Alaska were to allow their legislators to create such a privileged class. But hey, if you voters are handing it out, I’m glad to take it. I find it incredible you’re actually considering resurrecting this ridiculous travesty. Voters asleep at the wheel–legislature run amuck.
They sure are on a warpath to confiscate the PFD.
Why aren’t employees offered a choice? Why does it have to be one or the other?
Their Unions do not want them to have a choice. Plain and simple.
The math don’t math with a define benefit plan. All investment risk is with the employer. People working for 25-30 years and then getting paid another 25-30 years doesn’t make sense. There is a reason they no longer exist in most of American copies. Please tell your reps this is a no go. Can’t let this happen.
Okay, here is an honest observation from a tier 4 (401K) state employee.
I have no desire to saddle the residents of Alaska with the assumed liability of returning to the pension system and I get it, it costs too much.
However, the current 401K system isn’t working out very well. Employees are limited as to where they can specifically invest their funds, much more so than private companies 401K retirement systems. One minor example being that a state employee cannot use a percentage of their 410K to invest in real estate. In March 2023 some random assistant state attorney general decided that the state could be sued if the employee lost money in the real estate deal, thus none are permitted to do it.
Further, the investment company that the State requires all employees to use has been recently recognized by the state of Alaska Retirement board as doing a horrible job with respect to managing 401K retirement accounts. So much so that new state employees can’t even sign up for a managed retirement account and current tier 4 employees have been advised against paying for those services. Yet here we are over a year after the retirement board acknowledged there was an issue and the state hasn’t made a move to find another investment fund company to assist with managing 401k retirement accounts for the employees.
It seems to me that if state government would step up and fix the current system, much of this pension hype would disappear.
When you say that state employees cannot use a percentage of their 410K to invest in real estate, are you talking about using a portion of their 401k to use towards the purchase of a primary residence? I can’t take a portion my private sector 401k and purchase other outside investments, but I believe I could use some portion towards the purchase of a primary residence with the appropriate fees and/or repayment schedule.
The other question worth considering, is why there is such an unfunded liability for these DB retirements? Legislators have been mismanaging the state’s money for decades. Don’t blame the bills you have to pay for your inability to pay the bills.
I was a state employee under a defined contribution plan Texas,Teachers retirement system. They took a bit of every check. Its not bad. The good part is that THT plan will be solvent till after I’m gone. Theyrve got billions stashed away right now. The rules require them to be actuarily ound,for over 30 years , reviewed every year if they are considering a cost of living adjustment. It has to be reviewed in light of the fund’ s status.