Defined contribution plans in the public sector.

• Author: Crane, Roderick B.

Since the mid-1980s, 80 percent of newly established pension plans, primarily in the private sector, have been some form of defined contribution plan. While the vast majority of public-sector employees still participate in defined benefit plans, there has been a recent increase in interest in defined contribution plans by both public-sector employers and employees. Plan sponsors are examining defined contribution concepts as a way to supplement already-established defined benefit plans with another retirement savings vehicle for their employees.

Defined contribution plans can follow a number of different models - some entail risks for employers and employees, and some are not suitable or authorized for public-sector employees. Because of the number of options available to customize these plans and limit risks, however, defined contribution plans can help both employers and employees achieve results that defined benefit plans alone might not be able to offer.

There has been a decrease in the percentage of governmental workers covered by defined benefit plans, according to the Bureau of Labor Statistics whose 1992 survey of 1,051 public-sector employers with more than 12 million employees showed that 87 percent of full-time state and local government employees were covered by defined benefit plans. This compared to 93 percent coverage in 1987 and 90 percent in 1990. Nonetheless, it is expected that defined benefit plans will remain the predominant type of pension plan for public-sector employers for the foreseeable future.

This article summarizes the advantages and disadvantages of defined benefit and defined contribution plans for public-sector employers and discusses some defined contribution options that can stand alongside an existing defined benefit arrangement.

Defined Benefit Plans: More Pros than Cons

For many public-sector employees, defined benefit pension plans provide a meaningful and predictable source of retirement income. The certainty of a guaranteed retirement benefit that will continue until the employee's death makes a defined benefit plan particularly welcome, especially in the 1990s, when alternative sources of retirement income such as personal savings and home appreciation, are growing more slowly than they did during the previous decade. The security offered by many defined benefit plans that cover state and local government employees is enhanced by automatic or frequent ad hoc cost-of-living adjustments (COLAs) and early retirement options that include unreduced or subsidized pensions. These provisions are not common in the private sector.

Real and potential changes in Social Security might raise concerns for those public-sector employees who are expecting Social Security benefits. Reductions in Social Security benefits, which are being debated in both the Congress and the press, could make Social Security a less meaningful source of retirement income. In addition, recent increases in Social Security retirement age will require workers reaching age 62 in the year 2000 to stay in the workforce longer to reach full benefits. Consequently, employees who hope to retire early can expect a smaller Social Security benefit each month. Having the guaranteed retirement income that defined benefit plans offer adds some peace of mind to retirement-income planning and helps offset the smaller role Social Security may play for future retirees.

From the employers' perspective, defined benefit plans enable them to provide a comfortable retirement for their former employees, a commitment that many of them regard as a social responsibility. Defined benefit plans also offer...