By Mary McCleary
In 1997, Michigan ended the use of defined benefit plans for new state workers and placed them in defined contribution plans. Using Michigan’s actual transition data from 1998 to 2010, we extrapolated future state budget savings for Ohio if the state follows Michigan’s transition trend. Based on historical inflation, we assumed a yearly increase of 3 percent both for Ohio’s payroll and for the individual state worker. The starting salary for a new state worker in 2010 is from the Buckeye Institute’s report The Grand Bargain is Dead: The Compensation of State Government Workers Far Exceeds Their Private-Sector Neighbors.
Under the current defined benefit system, taxpayers pay 14 percent of each employee’s paycheck into the pension fund. For our analysis, we used two possible rates for the taxpayer portion of the defined contribution plan. The first rate is 10.2 percent, which represents the 6.2 percent private sector employer payment into Social Security plus the 4 percent average private sector 401(k) match in Ohio. The second rate is 7.1 percent, which represents half of the 6.2 percent private sector employer payment into Social Security plus the 4 percent average private sector 401(k) match in Ohio. We used this figure because private sector employees who receive Social Security at the income levels of state government workers will not “get back” 100 percent of the employer share.
Our analysis, detailed in the tables below, shows that, from 2010 to 2039, taxpayers would experience significant savings by moving workers to a defined contribution system. If the taxpayer contribution rate were 10.2 percent, taxpayers would save $3.3 billion over this time period. Similarly, if the taxpayer contribution rate were 7.1 percent, budget savings over the 30-year period would be $6 billion.
Under the new system, assuming a worker retires at age 52, his retirement account would total $383,087 (10.2%) or $266,659 (7.1%). If this worker waits to retire until age 65, his account would total $918,393 (10.2%) or $639,274 (7.1%). It is important to note that these figures only include the taxpayer’s share of funds set aside for each employee. These figures do not include the required 10 percent contribution that employees must make to their own retirement. If the employee’s additional 10 percent were included, the defined contribution accounts would roughly double in size.
True pension reform would, at a minimum, shift new government workers at the state and local levels into defined contribution plans as outlined herein. Such a shift would alleviate budget crises in the long term without hurting new workers. The real debate should focus on how to reduce the unfunded pension liabilities for current state and local workers. Our Grand Bargain report contains several options that would substantially solve this problem.
To see the tables associated with this report, click here: Pension Plans
This report was written by Mary McCleary when she was a policy analyst at the Buckeye Institute.