Existing State “401k” Plans: Michigan, Alaska & Washington DC

We suggested in an earlier post that it was just a matter of time before many state and local governments would find it necessary to abandon their expensive defined benefit employee pensions and replace them with 401k-type defined contribution retirement plans. In the private sector this transition has taken place over the last 25 years. Government budgets are under intense pressure (largely due to rising pension costs) and it seems highly unlikely that they will be able to successfully raise taxes - not to increase services - to pay into pension plans.

A few states have already made the switch to "401k" style defined contribution plans and many more are actively considering the move. The National Conference of State Legislatures published an overview report of state DC retirement plans in September 2009. According to this report, just two states (Alaska and Michigan) and the District of Columbia had defined contribution plans as primary retirement systems for new employees. ¹ Below is a summary of the 401k-type defined contribution plans ² offered by these governments:

State	Year Adopted	Primary or Optional Primary	Details
District of Columbia	1987	Primary for new hires after October 1, 1987	The District government's primary retirement plan for eligible employees first hired on or after October 1, 1987, is a "defined contribution" plan, with benefits based on 100% employer-provided contributions plus earnings over the course of the participant's working years. The District funds this plan; there is no employee contribution. The current employer-paid contribution is 5% of the base salary (5 .5% for Corrections Officers). Employees must have one year of continuous service to participate, and they are fully vested in the Defined Contribution Pension Plan after five years of continuous service.
Michigan	1996	Primary for new state employees hired on or after March 31, 1997.	Mandatory employer contribution of 4 percent of each employee's annual compensation to a personal Defined Contribution Account. Employer match of employee voluntary contributions up to an additional 3 percent of compensation. If an employee contributes 3 percent, the employer will match the 3 percent employee contribution to total 10 percent of employee's compensation. Employees may contribute additional voluntary amounts to their Defined Contribution Account or other tax-sheltered plans to the extent permitted by the Internal Revenue Code with no employer match. Employees will be 100 percent vested in the employer contributions after four years of service.
Alaska	2005	Primary for new hires on or after July 1, 2006	8 percent mandatory member contribution 5 percent employer contribution to the Defined Contribution Retirement (DCR) Plan Member is immediately vested in the balance of the member contributions. Member is not 100 percent vested in the employer contributions until five years of service is accrued.

It is worth noting that the employer contributions for these state plans (4% - 7%) are significantly higher than the norm for private sector 401k's. According to Boston College's Center for Retirement Research, for private sector workers, "the typical employer match consists of a 50 percent match on 6 percent of the employee’s salary...the typical employer match is thus 3 percent of employee earnings. Most employers permit their workers to continue contributing on an unmatched basis past the 6 percent match level."³

Understandably, public employees (and their unions) will not readily give up the lifetime guarantee of a defined benefit retirement for a 401k-style retirement plan - even one that is far richer than than their private sector counterparts enjoy. Instead, this type of change on a nationwide scale will likely come about via a grassroots citizen movement fueled by outrage: outrage over the inequity of public vs private pensions and outrage over the higher taxes needed to fund public defined benefit pensions.

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Notes:

1. Several other states - including Colorado, Florida, Montana, North Dakota, Ohio, and South Carolina - offered DC plans as "optional primary plans" meaning "new employees may elect to be members of a defined benefit plan or a defined contribution plan, but must be a member of one or the other. Under current law in these states, both kinds of plan remain open to new members, and limited transfer between them is available." [↩]
2. IRS rules prohibited establishment of new governmental 401k plans effective May 6, 1986. Some governments - including Michigan - had 401k plans in existence on that date and were grandfathered in. Thus, Michigan's DC offering is, in fact, a 401k plan. [↩]
3. Why Did Some Employers Suspend Their 401(k) Match?, p. 2. [↩]