Defined contribution plans help save money in the long run by reducing the amount that the state and taxpayers must contribute toward employees’ retirement funds each year.
However, the employee becomes responsible for determining how much, and where they will invest their money, making the consequences of investment loss greater. If the employee does not put away enough money for retirement, the consequences could be dire.
Likewise, defined contributions often result in lower investment returns compared to defined benefit plan investments, which are managed by experts who are able to pool all defined benefit funds to their advantage.
Defined benefit plans guarantee stability for employees who dedicate their careers to a single profession, such as teaching. It encourages these workers to remain in the same profession until retirement. Defined contribution plans, however, seem to be better for young, mobile workers who may switch workplaces or professions several times throughout their career.
Direct benefit plans are also economically beneficial. Under the defined benefit plan, TRS retirees receive a set monthly payment regardless of the current economic situation. In contrast, direct contribution recipients’ investments can be negatively affected by economic changes, and may be reluctant to spend savings depending on the state of the economy.
Direct benefit plans depend on a healthy funding ratio, which Georgia has proudly maintained over the years. Georgia also expects a modest, but healthy 7.5 percent expected rate of return for all investments.
Despite the effects of the Great Recession, investment returns have sustained the amount necessary to pay all new and current retirees. Other states get into trouble with pension funds when their investments are risky and they assume high, unrealistic rates of return.
How ERS 401(k)-type plan works
New state employees are automatically enrolled in the 401(k) plan at a contribution rate of 5 percent of salary and the state provides an employer match of 3 percent. Employees can adjust their contribution rate but the state will match 100 percent of the first 1 percent by the employee and 50 percent of each additional contribution up to 5 percent. Employees can increase their contributions beyond 5 percent or they can choose not to participate at all.
For the defined benefit part of the retirement benefit, the employee contributes 1.25 percent of salary and the states employer contribution is 18.87 percent of salaries.
Investments are important
TRS is also responsible for investing retirement funds for its members. In 2013, $3.5 billion in benefits was paid to retirees. The recession is still affecting total asset amounts despite improving investment rate returns since 2010.
It is vital for TRS to invest its members’ contributions and ensure that TRS can continue to pay its retirees. Some legislators have proposed that a small percentage, 5 percent or less, of TRS investments could be placed into “alternative,” or venture capital investments.
As far back as the Barnes administration, there have been attempts to pass legislation that would invest pension funds in venture capital. ERS recently began this process in 2012 with the passage of SB 402, the Employees’ Retirement System of Georgia Enhanced Investment Authority Act.
However, ERS is investing in small increments of 1 percent or less each year and separate legislation would have to be passed to allow TRS to invest in alternatives. The ERS strategy has been very gradual and conservative to keep in line with the intent of the legislation.
Venture capital still remains a small subset of investments, but as of June 30, 2014, ERS has $21.9 million in private equity investments earning so far at a 6.8 percent rate of return. TRS alternative investments could be part of a larger investment strategy governed by the investment boards of the pension systems themselves with the ultimate goal of facilitating the best returns for the systems. But Governor Deal has pledged to follow the wishes of TRS members.
A large change that hasn’t received much attention has to do with pension reporting. Both TRS and ERS follow accounting guidelines established by the Governmental Accounting Standards Board (GASB), which sets the best-practice standards for financial reporting for state and local governments.
Some recent GASB reporting changes will improve financial reporting transparency, and while the underlying economics and health of the plan are not impacted, the new standards will result in recognition of liabilities that had previously not been reported in certain levels of participating employer financial statements.
Finally, the GASB changes will have no impact on how the systems are funded, as current budgeting will continue to be set in accordance with generally accepted actuarial standards.
I may be reached at
234 State Capitol, Atlanta, GA 30334
(404) 656-5038 (phone)
(404) 657-7094 (fax)
E-mail at Jack.Hill@senate.ga.gov
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