The 401(k) retirement plan has been getting great press this election season. Candidates running in Republican and Democratic primaries are touting 401(k)s as the secret to ending Illinois’ huge pension liabilities.
Don’t bank on it.
Employer-sponsored 401(k)s, which started in the 1970s, allow workers to save some of their earnings tax-free until they retire. Often, employers will match at least part of their employees’ contributions. Workers don’t pay taxes until they withdraw their money. In the private sector, 401(k) plans have rapidly replaced traditional pensions.
The candidates who are touting 401(k)s like the fact that governments wouldn’t accumulate liabilities over the long term if they switched to a 401(k) system. If the employees’ accounts lost value in a stock market crash, that would be the employees’ problem. Even if the employees lost all their money, the governments wouldn’t have to step in. There’s no FDIC for 401(k)s.
But doing away with big government pension funds could hurt virtually every average investor in the state. As David Webber, a law professor at Boston University, recently wrote in the New York Times, big pension funds have the clout to push fund managers to improve investment returns. They can switch managers who aren’t doing a good job. They can put pressure on companies that overpay executives at the expense of investors. They can demand reforms.
Try doing that on your own with your personal 401(k). You couldn’t even get a return phone call.
Without big public pension funds, such as those in Illinois, investors would lose leverage. They could expect to see their savings gain less value over time. Only money managers and others in the financial class would be happy about that.
Yes, Illinois has a big pension problem. Massively underfunded pensions loom over the governmental landscape from the local level all the way up to state government. There are exceptions, such as the Illinois Municipal Retirement Fund. But the habit of underfunding pensions and adding a series of pension sweeteners without paying for them has created an almost unimaginable stack of IOUs.
But to say, as Republican gubernatorial candidate Jeanne Ives does, “I support a move to 401(k)s for all new workers,” raises false hope.
The state would have to fully fund new 401(k)s upfront. The existing pension debt wouldn’t go away, and government pension costs would rise because fewer new employees would be paying into the funds.
401(k)s also hurt the economy in other ways. They encourage people to retire early when the economy is booming because the value of their retirement funds soars along with the stock market. But that’s just when the economy needs as many workers as it can get.
In bad economic times, 401(k)s encourage people to keep working longer than they planned because their retirement funds have shrunk to the point that it’s not safe to retire. But that’s just when a few more job openings would be most welcome to people who can’t find employment.
Moreover, 401(k)s often include indecipherable fees that reduce returns, and employees are unlikely to manage their investment choices as well as pension fund professionals would. A 2012 study found 401(k) fees for a median two-income family could reduce a retirement nest egg by nearly a third.
The Illinois Supreme Court has made it clear that state and local governments must make good on the pension promises they’ve made. Switching to 401(k)s won’t allow the state to get out of obligations it already has incurred, but it could leave a new generation of workers without retirement security.
As Webber reports, such groups as the Koch brothers’ Americans for Prosperity, the Laura and John Arnold Foundation and the American Legislative Exchange Council are engaging in a multi-state push to replace public pensions with defined-contribution plans, such as 401(k)s.
Illinois should resist them. Switching to 401(k)s won’t erase our pension deficits. And doing so could cause long-range damage to both the state and its workers.
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