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Pensions Facing More Changes Than You Think

Alicia Munnell, the director of the Center for Retirement Research at Boston College, is a weekly contributor to “Encore.

A recent press story highlighted proposed pension cuts in San Diego and San Jose, California as pioneering efforts to rein in pension costs. These cuts were deemed newsworthy because they reduced future benefits for current participants, an action which at the beginning of the financial crisis was thought to have been impossible under most state laws. In fact, the San Diego and San Jose actions are consistent with developments in a number of other states where sponsors have recognized that they need the freedom to adjust future benefits to solve their pension funding problems.

How benefit promises have actually played out in the public sector in the wake of the financial crisis is an interesting story. On the one hand, public plan participants were thought to have a higher degree of protection than their private sector counter­parts. Whereas the Employee Retirement Income Security Act (ERISA) protects private sector benefits earned to date, it does not prohibit changes in future benefits for current workers. In contrast, in many states the constitution prescribes or the courts have ruled that the public employer is prohibited from modifying the plan. This prohibition means that employees hired under a public retirement plan have the right to earn benefits as long as their employment continues. Thus if the employer wants to reduce the future accruals of ben­efits, such a change usually applies only to new hires.

On the other hand, in the wake of the financial crisis, in many instances the “pension wealth” of both current employees and retirees has been reduced. The most direct way this reduction has occurred for current workers is through increases in required employee contributions. Such increases were possible because, while constitutions and state laws preclude benefit changes, they usually place no restrictions on how much the state can ask the employee to pay. Thus the employee continues to accrue the expected benefit, but the net contribution from the employer has been reduced.

The diminution of employer-provided benefits has not been limited to active workers. In some states, retirees have seen the reduction or suspension of their cost-of-living-adjustments (COLAs). In four states – Colorado, Minnesota, New Jersey, and South Dakota – the suspension has been challenged in court and the court upheld the change. The judges tend to argue that the COLA is separate from the core promised benefits, that retirees knew that the COLA was subject to change, and that the COLA suspension was necessary to prevent the long-term fiscal deterioration of the pension plan. In three states – Maine, Rhode Island, and Washington – suspensions have been put in place, and challenges are in court.

If one perceives the COLA as an integral part of the benefit, then the suspension would violate the ERISA provisions, which protect all benefits earned to date. Of course, almost no private sector defined benefit plans have COLAs, so a direct comparison is not possible.

Finally, both New Jersey and Rhode Island have cut benefits across the board for current employees. These cuts are currently being challenged in court.

The key point is that plan sponsors need to be able to cut future benefits for current employees. State constitutions and case law make this difficult. Nevertheless, a number of states have ploughed ahead and made changes, hoping the courts will uphold them based on the fiscal necessity to control benefit costs. So more reining in of benefits is going on than observers generally perceive.


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    • Can Someone Please Spell BANKRUPTCY ???

    • Quoting Justin …”Public employees should pay 50% of the costs of the pension. No more and no less”

      Wrong. The goal should be equal Public vs Private Sector Total compensation (cash pay + pensions + benefits). Currently, cash pay is very close in both sectors, but pensions and benefits are FAR FAR greater in the Public Sector. With equal cash pay, Taxpayers should pay no more towards Public Sector worker pensions than they get from their employers …. which is typically 3-5% of pay into a 401K Plan.

      With the TYPICAL Public Sector Plan requiring a level annual 30% of pay (50% of pay for the richer Plans of Police officers) to fully fund the pension over the working career of the employee, there is ZERO justification for Taxpayers to pay half of that high percentage.

      If Public Sector workers want such VERY rich Pensions THEY (NOT Taxpayers) should fund the entire amount greater than the 3-5% of pay that Private Sector Taxpayers typically get from their employers.

    • The sad fact is that current taxpayers are stuck paying for work that was done many year ago. All cost and no benefit.
      When public workers complain about contract rules, they don’t realize that their position will have to lead to two-tier benefit rules, and then to removing the expensive first tier employees. It is inevitable that many govt employees will have to face this choice.

    • So instead of being a nation based on laws, we are now a country that goes which ever way the wind blows. Contracts, and legally enforceable negotiations no longer mean what was agreed on by the parties. That my friends is a very slippery slope. If past employment and benefit contracts can be voided or alerted in the future where will it end. Soon a car dealer who begins to lose money will see fit to come to you and demand more money saying he didn’t negotiate the correct price at the bargaining table. Or the Doctor who has been treating your cancer says his past treatments are not covering his future costs so you’ll need to pay more, not only for the treatments in the past, but future ones too.
      We are a nation of laws for reasons of clarity, guidance and sanity. Otherwise chaos and anarchy rules. Public employees should pay 50% of the costs of the pension. No more and no less. Vesting in a pension systems should only occur after 10 years of actual service and miminum retirement ages should mirror community standards.
      Altering pensions, ones promised, earned and relied upon after 20, 30 or more years of service is wrong and everyone knows it, in their heart and in their head.

    • Quoting SeanN … “And what’s the primary reason those pensions are in trouble? Underfunding by state legislators (they failed to make actuarially required payments)”

      That statement taken by itself is the tail waging the dog.

      Not stated (because it would conflict the the writer’s agenda) is the ROOT cause of WHY full funding was not made …. because ALL Public Sector pensions (when compared to those of their Private Sector counterparts) are excessively generous (the taxpayer paid-for share of which is ROUTINELY 2, 4 even 6 times for safety workers, greater in value at retirement) ….. and THEREFORE extremely costly and difficult to fully fund.

      And …. under typical cost-sharing, the workers’ contributions (including all the investment earnings thereon) rarely pay for more than 10-20% of total Plan costs.

      With Public Sector workers earning no less in cash pay, there is ZERO justification for ANY greater pensions let alone ones that are multiples greater. Equal cash pay plus (the MUCH) greater pensions results in significant overcompensation. This is not necessary to attract and retain a qualified workforce and is grossly unfair to Taxpayers.

      Bottom line …… the excessive Plan benefits and the 80-90% cost share allocated to Taxpayers makes these Plans impossible to fully fund in the absence of stratospheric
      investment returns.

About Encore

  • Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.