Follow these principles to design secure, attractive employee retirement benefit plans
By Richard Hiller
The public sector remains a stronghold of the traditional defined benefit pension plan. But as state and local governments continue to struggle with underfunded public pensions, their approach to funding the retirement of their employees is evolving. Some of them are tackling the financial challenges by raising the retirement age, reducing benefits for new hires or increasing employee contributions. Many are considering alternative retirement plan designs. One thing is clear: Something must be done about retirement benefit plans for public sector employees — to protect both the financial security of current and future retirees and the fiscal health of state and local governments.
Helping public sector employees maintain financial security to and through retirement has been TIAA-CREF’s primary focus for over 90 years. We have developed a set of principles for the design of an effective primary retirement benefit plan. The debate around public sector retirement plan design will continue to grow in volume and intensity. These principles can help establish a rational and objective basis for measuring and evaluating the merits of alternative benefit designs under consideration.
Plan designs that create a substantial uncertainty that participants would receive adequate and secure retirement benefits should be avoided. Pre-retirement survivor and disability benefits should be included in the overall retirement plan design.
- A primary retirement benefit plan should be designed to provide adequate and secure income throughout retirement as a primary objective. Meeting this primary objective supports critical workforce management objectives, including attracting and retaining quality employees and facilitating an orderly transition into retirement.
- The plan should be designed to provide full-career employees a target retirement replacement income from all sources during retirement sufficient to maintain the employee’s pre-retirement standard of living during retirement.
- The plan should be designed to recognize the needs of a mobile workforce by providing equitable benefits for less than full-career employees consistent with workforce attraction, retention and budget objectives of the employer.
The plan should be designed to create a high degree of certainty that participants will achieve an adequate and secure income throughout retirement, taking into account the following risks:
- Funding shortfall risk – the risk that the total employer and employee funding is not adequate to achieve the desired income replacement objectives
- Longevity risk – the risk the retiree will outlive his or her retirement assets
- Investment risk, including normal market volatility and that attributable to more major economic downturns
- Inflation risk
- Annuitization rate risk
- The plan should be designed to recognize that achieving retirement income adequacy and security for employees is a shared employer/employee responsibility. Employee participation in a primary retirement benefit plan must be mandatory. Both employers and employees should share in the cost and risk of funding benefits provided by the plan.
- Because state and local governments have a social welfare interest in the financial security of their residents during retirement, plan designs that provide a base level of employer-funded guaranteed lifetime retirement income are preferred.
- The structures of the retirement program and the individual plan components should be consistent with and support these principles and may include defined benefit, defined contribution or hybrid approaches as long as such are consistent with the previously stated principles.
Defined contribution elements should contain features that maximize the certainty of achieving the retirement income adequacy and security objectives stated in these principles.
- Employee-directed investments should be limited and managed as necessary to achieve the retirement income purposes of the plan.
- Investment menus should be limited and include one-choice asset allocation options.
- Participant investment advice should be made available with no direct separate charge to participants.
- Low-cost lifetime income products should be made available from financially strong providers during the accumulation phase to allow staged purchases of retirement income and to lessen annuitization rate risk.
These principles offer public employee stakeholders a way forward as public retirement benefit plans are increasingly scrutinized and reconsidered. As stewards of public employee retirement security, it is incumbent upon leaders to act with reason, fairness and a measure of expediency. Public sector employees and taxpayers deserve nothing less.