A better public sector retirement plan for the modern workforce 

Defined benefit (DB) and defined contribution (DC) plans have well-documented shortcomings in meeting the needs of employees and employers in the modern age. Yet, these plans continue to be standard, especially among public pensions. With an evolving workforce, it is time to build the next generation of retirement plans. 

Beyond the growing pressures of crippling unfunded liabilities, DB plans suffer from a fatal flaw – they are unable to meet the portability needs of today’s highly mobile workforce. Only about one-third of plan participants will ever receive a meaningful benefit from a public DB plan.  

Another significant shortcoming of DB retirement plans is a failure to address specific individual needs. In a traditional DB plan, every person with the same salary and length of service is eligible for the exact same annual benefit. But treating everyone the same ignores the reality that individuals are almost never average. Individuals have different needs based on many factors, such as health or other sources of income.   

A typical DC arrangement suffers many of the same shortcomings. Managing investment risk is often solely on the shoulders of participants. Default investments often use target date funds, so every person with the same birthdate has the same investment mix regardless of circumstances.   

Neither DB nor DC plans are able to meet the needs of broad swaths of individuals. Historically, cost restrictions have made it difficult to design a plan that recognizes individual needs while covering a wide range of participants. Fortunately, that is no longer the case. 

To address these traditional design shortcomings, and in partnership with the Pension Integrity Project at Reason Foundation, we applied decades of retirement plan-related experience to develop a new design approach: The Personalized Retirement Optimization Plan (PRO Plan). This new plan design uses a mix of tested and proven options, making it easy for policymakers to implement. Offering a wide range of individual flexibility in contributions and annuities, the Pro Plan can better fit the unique retirement needs of each individual, making the plan advantageous not only for employees but for employers looking to better serve and retain their workers. 

The PRO Plan starts with the endgame in mind: a lifetime of inflation-protected replacement income. With immediate or very short vesting periods, the plan allows all participants (not just a few) to earn meaningful benefits. It also allows individuals to tailor and structure funding of the target benefit and benefit distribution strategy by first using independent financial advisors and/or advice tools to determine the appropriate investment strategy.  

All other assets available to the individual are considered, including other retirement plans, spousal assets, inheritance, and others. While participant input is critical for success, it is not overly burdensome and only needs periodic updating. This input enables the creation of an appropriately risk-managed and liability-driven portfolio that is adjusted as appropriate throughout the working career. Utilizing a combination of plan-provided annuities and other distribution methods, a default income plan is created that is specifically tailored to the individual.   

Our analysis comparing this new design to existing options finds that the PRO Plan addresses many of the common shortcomings and enables each participant to address their specific retirement needs. Using existing market-based products and modern financial technology, the PRO Plan enables government employers to provide lifetime-guaranteed benefits to their employees, and in a way that is cost-effective. Our research indicates that our new plan design could meet the needs of retirees at 28 to 38 percent lower cost than it would be for an individual covering lifetime benefits on their own. 

Applying some of the best features found in DB and DC plans, along with modern financial technology, the PRO Plan can meet both employer and individual employee needs for a more effective retirement plan. Rather than attempting to fix current plans, the PRO Plan is a design that should be considered throughout the public sector as a plan that policymakers can fully implement today.