Amidst great investment returns, public pension systems should reassess plan designs

Public pension systems across the country are reporting excellent investment performances from the latest fiscal year. A number of public pension plans have even reported record investment returns in the high 20% to low 30% return range. But financial experts have also noted that some public pension systems’ investment returns have still underperformed the market in some cases and are not likely to continue to be this great into the future.

Since public pension plans smooth their asset returns over a number of years to manage market volatility, any properly risk-managed retirement-focused investment will somewhat underperform the market in up years but outperform the market in down years. For this reason, and others, any praise for the good investment results for public pension plans is justified and should not be dismissed. At the same time, while there is ample reason to be happy about excellent asset returns, there is also a danger that plan sponsors and retirement systems may sit back and rest on their one-year laurels.

Public pension plans should always examine an important question— Are the designs of their plans still working?

While the pressure to improve investment performance is somewhat, or temporarily, lifted, policymakers should take this time to focus on the retirement plan design issues that may be impacting their long-term ability to meet their primary objectives of enabling public employees to maintain a certain standard of living in their retirements after careers of public employment.

If pension plan sponsors do not examine the design of public retirement systems, it’s difficult to know whether things have drifted off course. This is especially important considering the changing career mobility of state and local government employees. According to the Bureau of Labor Statistics, the median tenure of a state government employee in 2020 was just 5.6 years. While this is longer than the 3.6 years for all private-sector employees, it is hard to escape the conclusion that workforce mobility and benefit portability issues for public employees are an increasing concern to their retirement security.

The Employee Retirement Income Security Act (ERISA) is the set of regulations governing private-sector retirement plans. While not directly applicable to the public sector, ERISA is often recognized as providing best case designs across all employment sectors. Many public plans have vesting periods longer than the ERISA maximums. Vesting forfeitures and the decreasing value of frozen deferred benefits for public employees who leave before retirement eligibility clearly have a large negative impact on employees’ retirement security. 

While no single plan design will perfectly meet the needs of all employees as well as all employers and taxpayers, some newer public pension system designs can effectively address today’s realities of employee mobility while still providing for lifetime income security.

The backbone of new retirement plan designs is the advancement in financial technological capabilities that enable defined benefit-like investment and lifetime income solutions to be utilized at the individual plan participant level. Technology enables this optimization approach to be provided to individuals at a low cost compared to what it would have taken some years ago to provide the same capabilities. With this new retirement optimization approach, individualized retirement savings and benefits can be structured to more effectively adjust to changes in an individual’s career and life circumstances and provide flexibility to select the level of lifetime income needed to reflect differences in expected longevity, dependent needs, and the availability of other financial and income resources. This will both better meet employee needs and better manage costs for employers and taxpayers.

The traditional “one-size fits all”  defined benefit plan long favored by public retirement systems falls short of meeting the retirement security needs for too many state and local government employees, particularly younger, newer employees. Now is the time for policymakers to aim higher by focusing on their current retirement plan designs. Failure to do so may mean that a retirement plan will continue to fall short in providing optimal retirement options to new public workers to the detriment of employers, employees, and taxpayers.