Peachtree City’s budget crisis has its citizens debating — a charitable description — the appropriate mix of cutting city staff, cutting city services or raising taxes. Amidst the verbal rock-throwing is an assertion that city employees will double-dip into taxpayers’ pockets at retirement since they have both a defined benefit pension and a defined contribution 401K plan.
As usual, the deeper the passion of the argument, the more quickly facts get trampled.
Actually, such “hybrid” retirement plans are becoming more common for precisely the opposite reasons as those hotly argued. Hybrid plans that split a retirement plan between defined benefit and defined contribution actually shift part of the cost, and part of the risk, away from the employer and to the employee. I’ll explain briefly, if you can bear it.
A defined benefit (DB) plan assures the retiring employee a specific monthly payment during retirement based on age, years of service, highest earnings etc.
Before retirement, the employer and the employee contribute to the plan, which is invested in securities with the intent to grow to make the funds available at retirement to pay the guaranteed pension.
But what happens if the invested pension funds seriously decline when securities markets take a dive, as they have several times in recent years? What happens if employees live longer than actuarially expected? The risk is entirely on the employer to make up any pension shortfall because the employee benefit has been “defined.”
Traditionally, corporations and federal, state and local governments have offered DB pension plans as an incentive to attract and retain good employees for the long term. But as medical advances made a long retirement life more common, the increasing pension burden on the employer gave rise to alternatives we now call defined contribution (DC) plans, of which the 401K is one.
DC plans make their definition on how much the employer and employee contribute, but the employer makes no guarantee whatever as to how much will be in the plan at retirement or how much the employee will be able to take out of the plan in retirement. The risk in a DC plan shifts away from the employer to the employee.
U.S. businesses have been leaving DB plans in favor of DC plans in droves for decades simply because the DB pension risk is too high to bear, especially in volatile securities markets.
In the private sector, establishing a new DB plan has become somewhat rare; some now use only DC plans while others keep a reduced DB plan and add DC plan components in a “hybrid” arrangement. The international company my wife works for uses such a hybrid plan.
Governments have been slower to follow, but many are recognizing they can’t afford DB guarantees and are adopting hybrid plans to shift cost and risk to employees. As of 2008 about 21 percent of public sector employees had been shifted away from DB plans, compared to 67 percent of private sector employees.
As for Peachtree City, I don’t know when they shifted to a hybrid plan for employees, but I can tell you the motivation was to shift part of the retirement plan cost and risk away from the city (read “taxpayers”) and to the employee.
So, let the games continue in the debate, including reckless assertions that we could use temporary employees to get city jobs done, or that the city doesn’t need any pension benefits to attract and keep good employees.
But reading the city’s hybrid retirement plan as a double-dip into taxpayers’ pocket is worse than reckless; it is 180 degrees wrong.
[Terry Garlock is a Certified Financial Planner. He lives in Peachtree City and writes columns occasionally for The Citizen. His email is tgarlock@mindspring.com.]
