Defined Benefit occupational retirement saving schemes reward those who reach a ‘retirement age’. Regulatory provisions require that employees leaving after minimum periods (and who are ‘vested’) should have a proportion of the accrued benefits ‘preserved’ until the retirement age. That may make things better for short-service employees but only partly so. This 2012 report looks at the status of short-serving employees who belong to public sector pension schemes.
“Both a stylized model and evidence from the HRS [Health and Retirement Study] show that final earnings plans are back-loaded and short change short-service employees.”
The design of a retirement savings scheme (or any other employee benefit programme) should aim to achieve agreed HR objectives. Aside from rewarding long-serving employees who ‘retire’, it’s difficult to see what the typical DB pension promise is aiming to achieve. This seems particularly important where employees are not entitled to Social Security pensions, as can be the case for US public servants.
“It is very difficult to argue that this outcome is the result of an optimal design to attract and retain workers who will stay with their employers for their entire careers. The design varies dramatically with the presence or absence of Social Security coverage, and it is unlikely that Social Security coverage is systematically related to the desired workforce profile.”
The report suggests that public sector employers should be re-considering their current Tier 3 pension programmes:
“Thus, continued reliance solely on final earnings defined benefit plans raises human resource and equity issues as well as financial concerns.”
The financial concerns relate to inadequately funded DB promises where costs are effectively shifted to future generations of taxpayers. Those risks relate not just to current workers but also to current retirees.
“On the human resource side, final earnings plans produce strongly back-loaded benefits. These incentives may be desirable for some types of employees, but it is unlikely that they are appropriate for all. More importantly, for the topic of this paper, they deprive short-term employees of retirement protection, especially for those systems that do not participate in Social Security.”
As the report says “It is hard to believe that the current design of pensions in the public sector reflects the existing needs of public employees.”
PensionReforms thinks that all employers, not just those in the public sector, should be revisiting DB promises and not just on behalf of short-service employees (the subject of the report). Even if the ‘true’ annual worth of a DB promise could be identified for a given employee (three actuaries will give three different answers to this basic question), there is a small chance the employee will collect the worth of that accrual and so it isn’t possible for the employer to know whether total annual remuneration is ‘fair’ in the year of accrual. Given a fixed overall remuneration budget, DB promises are also regressive and discriminatory (females over males; married over single).
Aside from all this, DB promises are complex, uncertain and, as the report explains, subject to financial promises that may not be kept. And in this particular case (US public employers), PensionReforms suggests it is most unwise to opt-out of Social Security pension coverage. That possibility comes from a different age of life-time public service and magnifies the problems of short-service employees. (File size 247 KB; 64 pp) 703