Florida’s public defined contribution retirement plan has a big flaw

Defined contribution retirement plans can be excellent retirement vehicles for today’s mobile workforce if the plan is designed around a set of best practices. These best practices include clearly stating the objective of the plan as a primary retirement vehicle—the main source of income that an employee would rely upon in retirement, which distinguishes them from supplemental savings plans.

In the Summary Plan Description for the Florida Retirement System’s (FRS) defined contribution (DC) Investment Plan, it is stated that:

Financial security when you retire is an important goal, and one that the FRS can help you achieve. The FRS has two retirement plans from which you can choose to help you meet your retirement goals: the Pension Plan (defined benefit) and the Investment Plan (defined contribution). Each FRS plan is designed to provide you with a good foundation for financial security when considered along with Social Security, other retirement programs, and your own personal savings (such as savings accounts, IRAs, and deferred compensation programs offered through your employer, among other resources).

Clearly, the intent of the Florida Retirement System’s plans is to provide the means, when combined with Social Security and other sources of retirement income, for retirees to achieve and maintain financial security in retirement. The Florida Retirement System’s Investment Plan does an excellent job in meeting most of the identified best practices, like defaulting new employees into the defined contribution plan and providing a variety of affordable and flexible investment options.

The one glaring exception to this, however, is that the DC plan’s total contribution rate is woefully inadequate to fund a lifetime retirement benefit. For regular class employees—which constitute the majority of FRS members—the employer contribution is 3.3% of salary and the employee contribution is just 3% of salary. This total of 6.3% is effectively half of the 12% to 15% most retirement experts consider necessary to fund retirement (when combined with Social Security and the other sources of income as mentioned above). Because of this, the Florida Retirement System is not able to live up to its own stated objective of providing “a good foundation for financial security.”

While raising contribution rates is the obvious solution to this problem, doing so would be admittedly not cheap. Doubling the contribution rate is clearly an expensive proposition that cannot be treated lightly. Several factors should be considered when public pension systems are contemplating a contribution increase:

• The increases do not have to be accomplished all at once. A multi-year plan can be put in place to gradually increase the rates over several years.
• The increases can be split, in some combination, between employers and employees. The full burden need not fall on employers.
• In a defined contribution plan, the employer’s obligation is fully met when the contributions are made. In other words, the budgetary requirements are completely defined. There can never be any unfunded liabilities created so there is no budgetary unpredictability.

Not meeting the contribution rates necessary to properly fund retirement is not without costs either. As individuals arrive at retirement age following a career with retirement contributions of just 6.3%, even combined with the income from Social Security and other retirement assets, total retirement income will most likely be insufficient to provide financial security. Various high-cost state-provided social services may be necessary to help support the individuals in retirement. Alternatively, individuals might well postpone retiring because of the lack of sufficient retirement assets. In this instance, the reality is the employer would be unable to replace that employee with a younger, lower-paid one, and be left with higher costs and possibly lower productivity from an employee who really doesn’t want to be working any longer.

Even though the Florida Retirement System’s Investment Plan is a well-designed defined contribution retirement plan, the substantial contribution deficit effectively limits its ability to live up to its stated goals and threatens its long-term viability. While the solution is clear, it is not inexpensive. With effective budgetary planning, the Investment Plan can fully meet best practices and live up to the clear objectives stated by the FRS.