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Research & Commentary: Solution for Illinois Pension Crisis Is Closer than You Think

May 19, 2017

In this Research & Commentary, Matthew Glans examines a proposed pension reform plan in Illinois that would use an existing model to implement a defined contribution model for new state workers.

The pension system in Illinois is undeniably broken, and funding the system has become increasingly difficult. Illinois has the weakest funding ratio in the nation, at just 37.6 percent. (The national median funding ratio for state pension systems is around 74.6 percent.)

Without an overhaul of the current pension model, which is unsustainable, Illinoisans will see substantially higher taxes or government services dramatically cut to bail out the state for its imprudent policies.

One new proposal recently introduced uses a model currently thriving within the Illinois retirement system. It has added stability, cost certainty, and portability to the system by incorporating a defined-contribution model for state workers. Under these plans, workers own their pensions and can take the pensions with them if they enter the private sector. Defined-contribution plans prevent the burden on taxpayers from rising automatically in future years.

Under a defined-contribution plan, employers pay a fixed amount during the course of a worker’s career, this amount is then deposited into a personal account which the workers controls and manages, This allows the worker greater control over their retirement and the ability to customize it to their own needs. These plans not only give worker’s more control over their own money but give more budget certainty to taxpayers.

The new proposal would require new state employees hired on or after July 1, 2018, to enroll in a 401(k)-style plan instead of a traditional pension plan. The plan would also give state workers across the five state retirement systems the option to move to a 401(k)-style plan for benefits earned going forward.

Under the new plan, state workers who are not covered by Social Security would be required to set aside a portion of their salary each pay period. This contribution would be divided between the employee, who would contribute 8 percent of each paycheck, and the state, who would match that contribution with another 7 percent. Workers covered by Social Security would share a 3 percent contribution with the state. The defined-contribution system created under the proposal would actually be superior in some ways to private plans because the state worker is required to make contributions to their accounts, so their retirement funds are almost guaranteed to grow steadily.

One interesting fact related to this proposal is that it is based on a retirement program that has existed in Illinois since 1998; it’s an option given to the state’s college employees. Since the program was launched, more than 20,000 state university workers have opted to join the 401(k)-style plan.

Ted Dabrowski and John Klingner of the Illinois Policy Institute say this enrollment figure is impressive, because the 401(k)-style plan is not the default plan offered by Illinois’ public universities and colleges. The defined-contribution plan is far more stable than the college workers’ pension plan, which, according to Dabrowski and Klingner, only has 41 cents of every dollar needed today to pay out benefits to retirees. This has led to 15–20 percent of new workers choosing the 401(k)-style plan.

Kicking the public-pension can down the road would only serve to delay the problem, and increasing taxes and ignoring the core problems created by defined-benefit systems would only ensure the pension system will never become solvent. Comprehensive reforms that allow governments to better manage employee retirement costs are desperately needed, both in Illinois and across the country.

This proposal is a first step toward substantive reforms that can cut costs and manage future pension liabilities while protecting existing benefits for public employees. Defined-contribution plans, which are used extensively in the private sector, would allow the state to lower its pension costs and give employees greater control over their retirement plans.

The following articles examine state pension reform from multiple perspectives.
 

Pension Reform Plan for Illinois: Right Under Its Nose
https://www.illinoispolicy.org/pension-reform-plan-for-illinois-right-under-its-nose/?ct=t(propertytaxes)&goal=0_9471dd8540-554d24c05f-14841201
Ted Dabrowski and John Klingner of the Illinois Policy Institute examine a pension reform proposal based on a model already operating in the state that could serve as a solution for solving the state’s growing pension crisis.

Not So Modest: Pension Benefits for Full-Career State Government Employees
https://www.heartland.org/publications-resources/publications/not-so-modest-pension-benefits-for-full-career-state-government-employees?source=policybot
Examining the benefits paid to state and local government employees, Andrew Biggs of the American Enterprise Institute argues drastic benefit reductions for current retirees would be unfair, but reforms to make public- and private-sector pensions more equitable should be on the table.

The State Public Pension Crisis: A 50-State Report Card
http://heartland.org/sites/all/modules/custom/heartland_migration/files/pdfs/27578.pdf
This Heartland Institute report examines problems facing public pension systems, including the enormous burdens public employee pensions pose in some locations. The report ranks each state according to the operation and relative disposition of the pension plans and suggests ways states might go about solving pension problems.

The Limits of Retrenchment: The Politics of Pension Reform
https://www.heartland.org/policy-documents/limits-retrenchment-politics-pension-reform
Daniel DiSalvo of the Manhattan Institute examines pension reform and argues states that are serious about keeping pension costs under control are increasingly introducing defined-contribution options or hybrid plans. As more states take this step, it will become less controversial and easier for other states.

Keeping the Promise: State Solutions for Government Pension Reform
http://heartland.org/policy-documents/keeping-promise-state-solutions-government-pension-reform
This report from the American Legislative Exchange Council describes the variety of pension plans governments use today and the advantages and disadvantages of each plan. It also provides several tools legislators can use to ensure governments can affordably fund retirement benefits for their employees.

The Real Cost of Public Pensions
http://heartland.org/policy-documents/real-cost-public-pensions
Jason Richwine discusses how to calculate the cost of public defined-benefit pension plans, compares the cost of these benefits to private-sector retirement plans, and refutes two of the most common arguments that attempt to prove public pension benefits are modest.

The Gathering Pension Storm: How Government Pension Plans Are Breaking the Bank and Strategies for Reform
http://heartland.org/policy-documents/gathering-pension-storm
The Reason Foundation discusses the looming crisis created by states’ continued use of defined-benefit pension plans, offering solutions and explaining why the current system is a disaster in the making.

Defined Contribution Pension Plans in the Public Sector: A Best Practice Benchmark Analysis
http://heartland.org/policy-documents/defined-contribution-pension-plans-public-sector-best-practice-benchmark-analysis
This white paper from the TIAA-CREF Institute “addresses best practice benchmarks for the design of public sector primary (core) defined contribution pension plans. It includes an examination of the environmental conditions and factors affecting these plans as well as general principles for the design of effective defined contribution plans. Selected public sector core defined contribution plans are reviewed against identified best practices.”

Let Employees Control Future of Retirements
https://www.cato.org/pub_display.php?pub_id=6556
Jagadeesh Gokhale and Peter Van Doren of the Cato Institute explain why the market is best-suited to relieve the fiscal pressures caused by state pension funds.

 

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website at https://www.heartland.org/publications-resources/newsletters/budget-tax-news, and The Heartland Institute’s website at http://www.heartland.org.

Whether sending an expert to your state to testify or brief your caucus, hosting an event in your state, or simply sending you further information on the topic, Heartland can assist you. If you have any questions or comments, contact Heartland Institute Director of Government Relations John Nothdurft at john@heartland.org or 312/377-4000.

Author
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance. In 2012, Glans was named senior policy analyst.
mglans@heartland.org @HeartlandGR