Think Millennials Aren’t Affected by Pension Reform? Think Again.

Impact
ByWilliam Freeland

For many millennials, retirement is a remote topic they assume can be safely ignored for the better part of the next decade. However, as the nation watches Detroit grapple with freezing pensions — many for workers who having been relying on those pensions for years to safely retire — millennials would be smart to start taking retirement planning seriously.

Public pension policy affects millennials’ compensation early in their careers, impacts their ability to switch between the public and private sectors later in their career, and affects the level of public services their state and local governments will be able to provide them in the future for their hard earned tax dollars.

The key issue at the heart of public pension policy is lies in a state’s pension arrangement  and whether or not it is a defined benefit plan (DB) or a defined contribution plan (DC). Former Utah State Senator Dan Liljenquist defines the difference in his recent American Legislative Exchange Council publication, Keeping the Promise: State Solutions for Government Pension Reform.

A defined benefit plan, which is the traditional definition of a pension, obligates the employer to pay the employee a series of payments in retirement regardless of how small the investment returns were. In a defined benefit plan, the employer decides how to invest retirement funds. About 90% of all public pensions are DB plans.

A defined contribution plan requires the employer to make certain payments into an employee’s account during that person’s tenure on the job. The employer’s obligation ends once the employee leaves the job. In a defined contribution plan, the employee usually decides how to invest retirement funds, and the employer makes no promises as to the amount of money the retiree will have. Most private sector jobs are defined contribution pension plans.

After college, I began as a researcher at George Mason University, a public university in Fairfax, VA. When I started, I was offered two choices: I could enter into a state defined benefit pension plan, which would require me to compile at least five years of service to the state of Virginia in order to ever collect a single payment, or I could enter the state defined contribution plan, which works much like a 401k. From day one, all of the retirement contributions made by my employer on my behalf would go into my own personal account. Whenever I chose to leave public service in Virginia, I would take 100% of the retirement contributions I made and and those made on my behalf by the state with me to my next job. The National Conference of State Legislators has a helpful map detailing what states have mandatory, optional, or hybrid defined contribution plans:

This arrangement is in stark contrast to what some states offer their young employees. Had I started in a state where my only option was a defined benefit plan, I may have been forced to accumulate 10-20 years of service to even qualify for a dollar of retirement benefits to be paid to me. If I ever considered leaving public service before that threshold, I would have been faced with leaving a significant amount of money on the table that, in theory, I was supposed to have earned as an element of my total compensation plan.

This is a huge problem for millennials interested in public service. They are faced with a “lock-in” effect that creates a sharp disincentive to ever leave public service once they begin. Or similarly, young people who first entered the workforce in the private sector are disincentivized from entering government later in their careers because of the service years requirement necessary to receive a retirement benefit payment; call this a “lock-out” effect. Though defined benefit plans and their accompanying service year requirements may create some degree of incentivized loyalty among government workers, it likely does more to discourage talented workers — young and old — from entering public service due to the “lock-in” and “lock-out” effects. 

Not only that, but as Dan Liljenquist further points out in Keeping the Promise: State Solutions for Government Pension Reform, defined benefit plans have a key shortfall: "Their long-term health is subject to manipulation for short-term political gain. A legislator who pushes through an increase in the service credit gets a political boost today from public employees. The cost of that improvement, however, may not be felt until long after that person leaves office."

This reality has two problematic outcomes that directly impact millennials.

First, millennials who do get stuck in defined benefit plans face a real threat that their promised benefits will get chopped in the future. As can be seen in the current experiences of Detroit and dozens of other municipalities, state and local governments often make pension promises they are not able to keep in the future. Given that state and local pensions are underfunded by $4 trillion or more, promised benefits to millennials in defined benefit plans are not particularly trustworthy or reliable.

Second, both millennials in public service and those in the private sector are affected by the looming pension crisis, which is threatening to damage many states and municipalities, just as it has in Detroit. Not only are retiree benefits cut by underwater pension plans, but public services are cut due to the strain on state and local budgets. That means millennials will face getting worse or fewer public services than their parents for the same or higher levels of taxation.

Luckily, this is a problem that state legislators, given a clear vision and the courage to act, can indeed fix. States like Michigan, Utah, Alaska, and Rhode Island have taken bold steps to fix their broken pension system. Good government for and by millennials requires commonsense public pension reforms to be undertaken sooner rather than later.