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Case shows desirability of LA retirement policy change

Louisiana House Speaker Jim Tucker got resolved that the Legislature should look at changing Louisiana’s retirement system from a defined benefit to a defined contribution plan. The experience of former Jefferson parish President Aaron Broussard shows why this is a wise move.

Until 1990, most state employees and many parochial and municipal employees on hiring were enrolled in a defined benefit retirement plan which means they receive a set annuity (adjusted optionally legislatively for cost-of-living increases) monthly. It is computed typically at one of 2.5, 3 or (for elected state officials) 4 percent of base salary times number of years served. Base salary is determined by an employee’s retirement eligibility (usually 30 years in or after age 55) date for the three following years if an employee requests to declare participation in the Deferred Retirement Option Program. During that time, money that would be paid upon retirement is banked and then becomes available shortly after retirement. If the 36 months passes and an employee continues to work, the money earns interest until it can be withdrawn.

Broussard, who resigned under pressure, has almost-immediate access to $185,000 (although for tax reasons he may wish to do otherwise) because of his DROP participation. Further, he will draw a pension of about $90,000 annually, or about 72 percent of his last salary. If he has any, also available is compensation for any sick/leave days which can be substantial.

By contrast, a defined contribution plan essentially takes tax-free a part of an employee’s pay (currently 8 percent) and a state match (currently 7 percent) and puts them into what is essentially an individual retirement account. Upon retiring, depending upon age, a lump sum and/or annuity payments could be taken. Unlike the defined benefit plan, there is no disability or survivor’s benefit after five years of service.

Just by using this example, the state can save in at least three ways and promote more efficiency. First, the state doesn’t have to pony up money three years before retirement which looses interest income for it. Second, by not allowing employees to leave potentially in the 50’s and paying them essentially full salary, experienced employees are encouraged to work longer instead of becoming double-dippers by taking another job after state retirement. Third, the state won’t be on the hook for extras like disability pay, survivor’s benefits, and the like which should be the responsibility of individuals to arrange.

Thus, while it is impossible to say with certain actuarially, it is likely that the state would save money this way. Even if those costs ended up the same, it would bring more order to the process (no more predicting about who retires and dies when, just known amounts going into plans every month) and keep the state from having to front money early by DROP. Note also perverse incentives for early retirement would be reduced, and the state would save money by eventually not having to a pension-management apparatus.

The matter’s urgency intensifies because of the huge deficit the defined benefit plan has triggered in the state. It’s now estimated that the unfunded accrued liability on accounts – which constitutionally must be solvent by 2029 – is almost $17 billion which creates a massive debt to be financed. While a switch in strategy won’t reduce this, it will prevent it from becoming larger through new obligations.

Committees have mused about ending the current system by the start of the next fiscal year Jul. 1. A defined contribution plan won’t deprive future employees of a generous retirement if they behave reasonably, and will save taxpayer resources. The example of Broussard’s case should sensitize politicians and the public to the wisdom of making the change.


buyapension said...

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Anonymous said...

What you fail to mention is that DROP is an actuarially neutral benefit, since your FAC is frozen at the time a member enters drop. This means any pay increases during that 36 month (or less) time period are not calculated for the final benefit amount. Therefore, some people will lose money by choosing DROP because their benefit would have been higher for life had they not frozen the FAC. Also, when a DB plan is closed, the UAL does continue to increase because there are no new members coming into the system to offset the cost of the older members of the system. Switching to a DC plan will not get rid of the UAL, but it will ensure that we will be paying welfare to the retirees of a DC system if they retire after any market downturn.