The state of Illinois has the distinction of having the largest amount of pension debt in the nation. Under the Illinois State Constitution, the state has the obligation to contribute to five pension systems: GARS (General Assembly Retirement System); SERS (State Employees Retirement System); SURS (State Universities Retirement System); TRS (Teachers’ Retirement System); and JRS (Judges Retirement System). For simplicity’s sake let us take a look at just one of these pension funds, namely TRS.
Of its total pension debt, the state owes TRS about $22 billion. The state’s unfunded pension liability has been characterized by some concerned citizens as the product of overly generous benefits. This is a widely held fallacy. The primary reason TRS lacks the assets necessary to cover its accrued benefits is due to decades of insufficient state funding, going back to Gov. Jim Thompson, who declared “pension holidays.” These were times when the governor and the state legislature diverted money intended for the state pension funds into the state’s general fund which is used to pay current state expenses.
The problem with this approach was that the state still owed TRS the money and, in addition, also owned interest on the funds diverted. Actuarial studies show that, had the state properly funded TRS since 1980, the TRS retirement system would be 98% funded today, instead of the current 64%.
In dealing with the question of “overly generous benefits,” it should be noted that the average annual TRS benefit stood at $40,128 during fiscal year 2007. It should also be noted that in most cases this represents the only retirement income for teachers because they do not collect Social Security. It should be further noted that every year Illinois teachers pay 9.4 percent of their earnings into TRS. That contribution is among the highest in the nation for public teacher pension funds.
No, it is not “overly generous benefits” that have created our current “pension crises,” but rather decades of irresponsible state leadership.
A number of concerned citizens have touted “pension reform” as a key to a more viable future for municipal and state governments. Their solution involves replacing “defined-benefit” (DB) plans with “defined-contribution” (DC) plans. They fallaciously believe that a DC system will solve funding problems. A defined contribution plan will not work at the state level (and I doubt it will work on the municipal level) because it will result in: 1) little immediate savings and 2) no help in reducing unfunded liability problems. Also, it certainly wouldn’t benefit employees who will be forced to trade a real pension for an imaginary one.
Under the state constitution, present employees are guaranteed a set income under the DB plan, so only new hires would take part in a new DC plan. The state would not realize substantial savings until those hires would become a significant percentage of the workforce. Also, switching to a DC plan does nothing to eliminate the $40+ billion unfunded liability the state is required to pay.
Switching to a DC plan would cost the state more in the short-term than maintaining its current DB plans. A defined contribution plan must be designed, set up, and put in place. Separate administrative and bookkeeping systems must be established for the different plans. Further, DB plans have lower overall retirement costs. They do this by pooling the risk associated with the market over a large number of participants. This means that DB plans, unlike defined contribution plans, can maintain a mix of investments, which will likely provide a higher rate of return than a DC plan.
In DC plans, employees who lack investment experience will be making their own investment decisions. Given the relatively small size of the assets available, the opportunities to invest will be greatly diminished and the trading costs considerably higher when compared to DB plans. The result … lower investment returns. The only beneficiaries of DC plans will be retail investment advisors.
To make matters worse it has been found through experience with DC plans that many employees do not contribute to plans made available to them, and many who do contribute do not save enough money for a secure retirement. It has been estimated that out of 1,000 people with DC accounts, 900 will not have enough money at the end of their careers-i.e. 300 won’t pay into them, 500 won’t contribute enough, and 100 will take money out of their accounts. A DC employee needs to put 18 percent into his account every year for 30 years or he will never be able to retire. According to studies by Vanguard and Fidelity, the average balance in a DC account at the time of retirement is $150,000. The median balance is between $55,000 and $65,000. Substituting a defined contribution plan for a defined benefit plan is a bankrupt idea.
The core problem is that the State of Illinois has a poorly designed tax system, which does not grow with the economy. This results in less revenue than is needed to maintain current public services and make the required pension payments. Until we deal with this central issue we will continue to generate inane solutions.