Illinois’ state pension systems are barreling towards insolvency. Without a complete pension overhaul, Illinois’ five pension systems may reach their breaking point.

There is only one way to prevent a collapse. Illinois must shift from defined benefit (DB) to defined contribution (DC) plans.

In a DB plan, an employer pays fixed, regular pension payments over a worker’s complete post-employment years. The payments are based on a formula tied to age, years of service and salary.

This means that taxpayers, not the government retiree, shoulder the investment and funding risks. The employer is obligated to pay the benefit that was promised, even if the pension fund has contribution shortfalls or poor market returns.  The employer (the government), and by extension, taxpayers, must make up any difference.

In contrast, in a DC plan the employer and the employee contribute fixed amounts to the employee’s private investment account. The amount one receives in retirement is purely a function of what’s in the investment account at the time of retirement.

Making the shift to a DC plan would certainly change how retirees manage for their retirements. And while at first glance the DC plan may look less attractive, current workers under nearly insolvent DB plans should embrace the DC option.

Economist Scott Beaulier makes clear that DC plans give individuals ownership over their retirements, enhance employee flexibility, improve labor mobility and keep taxpayers from dumping money into severely underfunded DB plans.

Individuals make their own investment decisions in a DC plan. They shoulder the investment risk. Their retirement benefits are equal to the amount contributed by both the employer and the employee, plus or minus any market returns or losses.

But when the employees shoulder the risk, doesn’t this lead to retirement benefits that may be less generous because of potential market losses? Well, yes. And that’s the trade-off facing public sector employees.

Let’s consider the other side of this trade-off, though. The state’s DB plans are unsustainable. The retirement funds may not be there in the next 10 to 20 years.

Illinois’ five DB plans currently owe more than $630 billion in projected pension benefits over the next 33 years. There is currently nowhere near enough money to cover these promised benefits. The state’s pension plans are dangerously underfunded. Already, the Teachers’ Retirement System in Illinois is estimated to have an 80 percent funding shortfall.

The benefits from a failed pension system will certainly not be very generous. The future retirement benefits, then, from the current DB plans are, at best uncertain.

In contrast, DC plans are, by definition fully funded. This is a positive. A practical reality is better than a pipe dream.  

For public employees, the switch to a DC plan means trading overly generous promises from nearly insolvent plans for benefits that are less generous but more secure and practical.

For government officials, the switch represents a stride towards fiscal prudence in state governance. It would also prevent a disastrous failure of the state’s pension systems.

And for taxpayers, the switch would ensure a much more stable fiscal environment in the future.

Unfortunately, we will not see a shift to a DC plan during Quinn’s special session tomorrow.

Lawmakers may, at best, tinker at the margins.