Tier 2 isn’t broken for Illinois’ career workers: expanding choice secures benefits

Illinois’ Tier 2 is a great retirement benefit for long-term state workers. But those who don’t spend their careers in government could be better served by the flexibility and portability of a defined contribution plan.

Government unions want to improve the retirements of state workers, but career Illinois employees already have it good and boosting plan costs won’t really help those whose state employment will be shorter.

Almost all of Illinois’ retirement plans got near perfect scores for long-term workers in the Equable Institute’s Retirement Security Report, which analyzed 345 plans in 50 states on 11 metrics. Long-term workers were defined as those with at least 20 years before reaching retirement age.

But the results were much less impressive for those spending less than 20 years in government service.

Equable’s analysis, based on pension pay as a percentage of working wages and cost-of-living adjustments along with other factors, indicates Tier 2 provides these workers with an adequate retirement benefit. Tier 2 earns a perfect score on income replacement, with most full-career employees meeting or exceeding the 70% of working-years’ salary commonly seen as adequate retirement income. The cost-of-living adjustment, which is automatic and linked to inflation, earns a solid score of 4 out of 5 points.

Tier 2 works well for long-term employees, but medium-term workers with 10-20 years of service and short-term workers with less than 10 years are underserved. Increasing Tier 2’s benefits won’t solve the problem because the vesting period of 10 years, combined with the inability to keep state retirement benefits after leaving a state job, prevent those who don’t stay in the system long-term from receiving them.

Increasing benefits doesn’t help people who never become eligible to collect them. Instead, Illinois should offer defined contribution plans, similar to 401(k) systems in the private sector, as an option to all state employees. Defined contribution plans offer more mobility and flexibility for the modern workforce.

Short- and medium-term workers underserved by a defined benefit system

Illinois introduced the Tier 2 pension system in 2010 to address the state’s massive pension debt, which now stands at nearly $144 billion. Tier 2 applies to employees hired after Jan. 1, 2011, and provides more modest benefits than Tier 1, which covers those hired before that date. The goal of Tier 2 was to reduce costs while maintaining retirement security.

Neither the Tier 1 nor Tier 2 retirement systems serve short- and medium-term workers well. This is because traditional defined benefit pensions were designed for employees who stay in a job for decades. Retirement age, final average salary calculations and cost-of-living adjustments have less impact for short- and medium-term workers. Those who leave before 20 years of service also get little to no benefit because vesting requirements are eight to 10 years. Additionally, pension contributions aren’t held in individual retirement accounts, making them difficult to transfer to a new job.

Wage and salary workers in the public sector today have a median tenure of 6.2 years. And that number is likely skewed because 3 in 4 government workers are aged 35 and older. Younger workers tend to stay in jobs for shorter periods. Across the public and private sectors, the median tenure of workers 55 to 64 is 9.6 years and 2.7 years for workers 25 to 34.

While public sector workers do stay in their positions for longer than private sector employees, turnover remains high, as is evidenced by the data on median tenure. Potential Illinois pension benefits may be generous, but only a fraction of newer public-sector workers will receive them because of steep eligibility requirements. Many will leave with nothing but a refund of their contributions.

Short- and medium-term workers need flexibility and mobility – both incompatible with a defined benefit pension. Illinois should offer defined contribution plans as an option for all government workers.

Defined contribution plans: Best fit for short- and medium-term workers

In Illinois, only State Universities Retirement System employees can opt into a defined contribution plan. This “retirement savings plan” enrolls about 18% of all active employees, with participation estimated to increase to nearly 30% in the future. A similar option should be extended to employees across all five systems.

Defined contribution plans can benefit both taxpayers and employees. They prevent the accumulation of unexpected liabilities driven by investment fluctuations and people living longer, plus give employees greater control over their investments. These plans also offer portability through gradual vesting, allowing workers to take part of their retirement savings with them if they leave before being fully eligible for benefits.

For example, Michigan Public Schools implemented a defined contribution plan for employees hired on or after Feb. 1, 2018, with vesting at 50% after two years, 75% after three years and 100% after four years. Indiana offers a graded vesting schedule of 20% per year over five years.

Strengthening retirement security for Illinois’ public servants is best achieved by increasing choice, which will in turn attract better job candidates and safeguard taxpayers.