Freezing defined benefit pension plans and shifting employees into defined contribution plans will involve increased costs to employers, reduced benefits, or some combination of both, according to a new research paper by the National Institute on Retirement Security.
The paper, “Look Before You Leap: The Unintended Consequences of Pension Freezes,” said such moves increase costs to employers and taxpayers because operating a DB and DC in tandem plan is more expensive than running only a DB plan, more costly because of front-loaded contribution requirements, and less efficient.
"States have found that abandoning a DB pension for a DC plan can actually increase costs, contrary to expectations,” Beth Almeida, NIRS executive director and co-author of the report, said in a news release. “Mostly, this is because (funding) regulations require pension obligations to be paid off sooner when a plan is frozen. It has a similar effect of refinancing from a 30-year mortgage to a 15-year mortgage, which drives up your payments. Accelerating pension payments is unlikely to be a helpful strategy for a state or local government looking for ways to manage through a difficult fiscal environment. Accounting rule-driven spikes in pension contributions can be significant as several states have found out.”
For example, Ms. Almeida said Alaska’s freezing of its public DB plans in 2005 required the state to boost its payroll contributions to the Teachers Retirement System to the Public Employees Retirement System by 14 and 9 percentage points, respectively.
Also, the report said that although employers may establish a new DC plan after freezing a DB plan, the replacement DC plans typically provide reduced benefits and possibly inadequate retirement income because DC plans have lower contribution rates and often earn lower returns.
