Best Practices In the Design and Utilization of Public Sector Defined Contribution Plans
54960995 © Ratina Thongteeka |

Policy Brief

Best Practices In the Design and Utilization of Public Sector Defined Contribution Plans

If properly designed, defined contribution plans can meet the employee retirement needs of today’s evolving and dynamic public sector workforce.

Executive Summary

The primary objectives of any employer-sponsored retirement plan should be to enable employees to maintain their standard of living in retirement after a career in the workforce, to meet employer needs for recruiting and retaining a talented workforce, and to do both in a financially prudent and sustainable manner.

Several types of retirement plan designs have proven successful over long periods of time in achieving these objectives. In the public sector traditional defined benefit pensions have become increasingly strained financially, leading to more difficulty meeting the needs of a modern workforce that increasingly sees public service as a temporary stop along a varied career path blended with other private sector work, as opposed to a destination for full-career employment.

This has prompted policymakers at all levels of government in the U.S. to consider introducing alternative types of pensions and other portable retirement plan designs—including defined contribution (DC) retirement plans—as a viable alternative to better serve the needs of shorter-tenured workers and reduce financial risks for employers.

A retirement plan that effectively meets both employer and employee needs can encompass any number of plan types, as well as combinations. When structured properly, DC retirement plans—plans with individually controlled investment accounts with contributions made by both employers and employees—can offer governments an approach to retirement plan design that garners retirement security for employees while actively working. Defined contribution plans accomplish this by modernizing the retirement option set and managing employers’ financial risks that are inherent in traditional pension plans that have accumulated to over $1.28 trillion in unfunded public pension liabilities nationwide in 2019.

However, like any tool, a retirement plan can be designed well or poorly, and the design will ultimately determine any retirement plan’s ability to achieve its objectives.

The best practice design elements discussed in this paper are critical to building well-structured defined contribution retirement plans and should be considered in any plan design effort.

DC plans have certain key advantages over other retirement plan designs. Among these, especially for public sector employers, is that no unfunded liabilities can be created with a DC design. Employer obligations are fully met when contributions are made. This stands in stark contrast to the traditional defined benefit pension systems that have created unsustainable unfunded liabilities borne by governments, and ultimately taxpayers, in a number of jurisdictions. DC plans are also well suited to meeting the career mobility needs of public employees in the modern workforce. In today’s norm of working for several employers during a career, a retirement plan that recognizes this mobility addresses a key societal need for retirement savings adequacy.

In defined contribution plans, the contribution itself does not guarantee any fixed level of future benefit, which can be seen, understandably, as a shortcoming of DC. However, this paper discusses how policymakers can effectively mitigate this risk by incorporating products like annuities and even using emerging DC design innovations that focus on “lifetime income” via new investment strategies and technologies that ensure annuity-like income throughout retirement.

Critical steps toward creating an effective retirement plan design include:

  • Clearly articulating plan objectives for lifetime income and other key considerations,
  • Clearly stating and explaining the plan’s purpose to all interested parties,
  • Communicating important features and educating participants,
  • Using auto-enrollment,
  • Providing adequate contributions,
  • Choosing appropriate portfolio design, and
  • Providing benefit portability and flexibility of benefits distribution.

Designing and administering a core defined contribution retirement plan that meets these best practices will result in a plan that meets the employee retirement needs of today’s evolving and dynamic public sector workforce. A well-designed DC plan will also enable crucial recruiting and employee retention needs of the public sector.

Utilizing defined contribution plan best practices can ensure retirement security for public employees without the risk of accumulating the types of unfunded liabilities associated with many public sector defined benefit plans nationwide.

Full Policy Brief: Best Practices in the Design and Utilization of Public Sector Defined Contribution Plans

This brief is part of the Pension Integrity Project at Reason Foundation’s Gold Standard In Public Retirement System Design series reviewing the best practices of state-level public pension systems and providing a design framework for states that are struggling under a burden of post-employment benefit debt. The series includes recommendations to help states move into a more sustainable model for employees and taxpayers.

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