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Hogan's 401(k) plan

"We are experiencing tremendous job growth, and an exciting economic resurgence in Maryland," Gov. Larry Hogan said. (Kevin Richardson/Baltimore Sun video)

When it comes to the financing retirement, Gov. Larry Hogan and the General Assembly are facing at least two challenges. The first, which gets a lot of attention, is ensuring the state retirement system has enough to finance employee pensions for many decades to come. But the second deserves more notice — the chronic problem of Marylanders, state employees included, who haven't got enough set aside for their golden years.

Governor Hogan's recent announcement that he wants future state workers to have the option of investing in a defined contribution plan — a 401(k) or its equivalent — instead of the state pension system must be considered for its impact on both. If done correctly, the administration can devise a program that doesn't hurt pension finances while encouraging state employees to save more for retirement. But, like most matters of finance, the devil is in the details.

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From the governor's perspective, the lure of a defined contribution plan is great, particularly if it means the state retirement system can shed future obligations. Maryland's system is not fully funded, and its earnings in recent years have been anemic. As in other states, there has been much debate about how best to bridge the potential shortfall (as well as the extent of the shortfall or even whether a gap exists at all).

But defined contribution plans have their own problems. Employees tend not to fully participate, and even if they do, they often make poor investment choices. And even if they make the right choices in stocks, bonds and other potential assets, there's the matter of risk — it falls entirely on them. Those who count on average stock market returns (perhaps 6 percent to 8 percent per year) could instead find themselves the victim of poor timing. Retire at the moment when the market loses 30 percent of its value and you could be woefully underfunded. That's much less of a problem for a pension plan which guarantees benefits — a circumstance made possible by enormous assets and a much longer investment horizon.

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It's no surprise that union leaders are already expressing concerns about any 401(k) push (even though Maryland already operates defined contribution plans as something employees can invest in on top of their pensions). They see any withdrawal from pension participation as problematic, and there are certainly scenarios in which it could be. If, for example, the loss of new participants means there's much less coming into the system in contributions while the outflow isn't comparably diminished, that's a problem for all involved, including the state treasury.

But there's also an issue that perhaps the unions aren't considering. Under 2011 pension reforms, it now takes state employees a decade to be vested in the retirement system. Those who leave state service early don't get any pension benefit, just a payout of the money they've contributed over the years. Some take the cash rather than roll it over into a retirement account, which could greatly hurt their chances for a comfortable retirement, an option that would be far less likely if it was in a 401(k). Wouldn't choosing a 401(k) from the outset make sense for people who plan to be in government service less than 10 years?

Perhaps the most important thing to keep in mind is that Governor Hogan is offering this as an option to future state employees, not a requirement. It won't affect current employees or teachers at all. We suspect participation will be modest, particularly given how rare pensions of any kind have become, but there's little harm in having that option. Perhaps all those who worry that the state will not meet its future pension obligations may prefer a system in which they have more control over financing their own retirements.

In the meantime, Mr. Hogan ought to look to other ways to encourage Marylanders to save more for retirement. Nationwide, the mean retirement savings for all families is less than $100,000, according to the Economic Policy Institute. The General Assembly took an important step to address that last year by establishing a state-run retirement savings plan for private employers with workers automatically enrolled. Such changes yield a benefit for taxpayers, too — the more Marylanders can afford to retire, the less chance they'll require help through publicly-funded safety net programs.

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