Stacked Retirement Benefits Could Protect Low-Paid Workers

According to a report co-authored by Alicia Munnell of Boston College’s Center for Retirement Research, public employers contemplating a shift to defined contribution coverage could increase security for lower-paid workers but possibly lose some more-senior, highly paid workers,


Public employers contemplating a shift to defined contribution coverage could increase security for lower-paid workers by taking a “stacked” retirement-benefits approach instead—but possibly at the expense of losing some more-senior, highly paid workers.

Public sponsors thinking about plan-design changes ought to consider offering employees defined benefit coverage as a base, but capping the benefit level at a specified dollar amount, says “A Role For Defined Contribution Plans in the Public Sector,” a paper released by the Center for State & Local Government Excellence. Public employees would get defined benefit coverage up to a certain level, such as $50,000 in annual income (indexed for inflation), and higher-paid employees would get defined contribution coverage for income exceeding the cutoff. “So you do not separate people: You separate incomes,” says Alicia Munnell, a co-author of the paper and director of the Center for Retirement Research (CRR) at Boston College, comparing it to approaches that shift all new workers into a defined contribution plan.

Nobody has tried this yet, apparently. “I am unaware of a plan that is using the model described in the CRR study,” says Keith Brainard, research director at the National Association of State Retirement Administrators (NASRA).

The idea has potential advantages for public plan sponsors, Brainard says. “This approach maintains the core features of a traditional pension plan, which promote retirement security, including pooled assets invested by professionals and annuitized benefits,” he says. “For states contemplating closing their traditional pension plan, this approach provides an alternative that could reduce employer costs and risks, while preserving core DB plan elements.”

This approach limits sponsors’—and thus taxpayers’—financial commitment to maintaining public pension plans, Munnell says. “The taxpayer absorbs the risk on the DB component, based on earnings up to $50,000 a year,” she says. “So they do bear some risk, but for pensions that are commensurate with their own earnings, instead of for people whose earnings may be two, three, or four times what they earn. This is capping the risk that the taxpayer has to bear.”

Lower-paid employees also would not have to decide on investments for a defined contribution account, and they would not suffer potentially steep losses when the equity market slumps, Munnell says. “Highly paid people are in a much better position to make those decisions, and to absorb some of the risk,” she says. This method “seems more reasonable in terms of the protection of lower-paid workers,” she adds.

The “stacked” method might lead more-senior public workers to leave, however. “This approach could limit the strength of pension plans’ ability to retain older workers,” Brainard says. “The farther their salary grows above the DB plan limit, the less incentive the plan would provide to stay on the job longer.”

To the extent that some public employees would not have a defined benefit plan covering their full earnings, it could incent them to find another job, Munnell says. “I view that as part of the tradeoff,” she says. “The gains outweigh the losses.” Shifting all new employees to defined contribution coverage also involves tradeoffs, she adds. At least with this approach, “higher-paid employees have a solid base on which they could augment their retirement income,” she says.

And in the private sector, Munnell says, many workers in their 60s find their defined contribution balances less than they need for retirement expenses, so they keep working. “People may stay on longer than they optimally would,” she says, “so it makes for a difficult labor-management situation.”