Part of Governor Andrew Cuomo’s “Tier VI” proposal to make pension benefits for public employees of New York’s State and local government more affordable and sustainable over the long term is an optional 401(k)-style plan. If the proposal is adopted by the legislature, new public employees would be able to choose between a more traditional defined benefit (DB) pension plan with a long waiting, or “vesting,” time to become eligible for benefits, or a defined contribution (DC), 401(k)-style plan that is used widely in the private sector and is becoming more common in the public sector.

Under the optional DC plan State and local employers would contribute 4% of an employee’s salary to a 401(k)-style plan and would match an employee contribution of up to 3%, for a maximum employer contribution of 7%.  The employee would select among pre-approved investment options depending on his or her preference for risk, and would vest after one year. Defined contribution plans are more “portable” than traditional pension plans because the funds accrued can travel with the employee when he or she moves to another employer. This flexibility fits with the realities of a modern career path in which an individual can expect to change employers at least five or six times in his or her working life.

401(k)-style plans have become the norm in the private sector. From 1986 to 2008 the share of full-time workers in private industry participating in DB pension plans declined from 76% to 24%.[1] Data from 2011 show that 58% of private sector employees have access to DC plans, and that fully 70% of those with access to it participate in it.[2] In contrast, just 30% of state and local government employees have access to a DC plan and their take-up rate is 56%.[3] 

Defined contribution plans are becoming more common among states, and generally follow one of three approaches:

1. Mandatory DC plans – Three states, Alaska, Michigan, and Minnesota, have closed enrollment in their DB plans, mandating that designated classes of employees enroll in a DC plan. These plans have vesting periods that range from three to five years. For example, Michigan mandated enrollment by State employees in its DC plan as early as 1997 and allowed members of the closed DB plan to transfer. Michigan contributes a minimum of 4% of an employee’s salary and matches an additional 3% if the employee makes contributions.  Employees have no mandatory contribution, but can give up to 12% of their salary.  Michigan’s vesting period is four years.
2. Optional DC plans – Some states, such as Arizona, North Dakota,[4] and New York, offer DC plans tailored to state university systems, but six states - Colorado, Florida, Montana, Ohio, South Carolina, and Utah - offer designated employees a choice between enrollment in a DC and a DB plan. Colorado, for example, began an optional DC plan in 2006 with a state contribution rate of 10.15% and an employee contribution rate of 8%. Ohio added optional plans for most classes of employees from 1998 to 2002. The contribution rates vary by type of employee; the state contribution for teachers is 10.5%, for state and other local government workers it is 14%, and for law enforcement and public safety officers it is 17.4%. Utah, which began offering an optional DC plan for employees hired on or after July 1, 2011, contributes 10% for civilian state and local employees and 12% for firefighters and public safety officers.
3. Hybrid plans – Hybrid plans offer a DC component, in which the employer matches a certain level of employee contribution, supplemented by a smaller predefined payout than what is typical under most DB plans. Nine states offer this type of plan. In Georgia, for example, employees have a DB plan with a low benefit multiplier and are also enrolled in a 401(k) plan.  Employees must contribute 1.25% of salary to the DB plan and 1% to the DC plan. The state matches the first 1% of the employee’s DC contribution and half of any other employee contribution up to 3% of salary. Nebraska offers a cash balance plan with a state contribution of 7.5% of the employee’s salary and a guaranteed annual investment return of 5%. Employees contribute between 4.3% and 4.8% of salary but cannot make investment decisions. Several states added hybrid options and defined contribution options at the same time.

By Elizabeth Lynam and Connor Mealey

[1] William J. Wiatrowski, Bureau of Labor Statistics, “The Structure of State and Local Government Retirement Benefits, 2008,” posted at www.bls.gov on February 25, 2009.

[2] Bureau of Labor Statistics, National Compensation Survey, Employee Benefits Survey, Table 2: Retirement Benefits: Access, Participation, and Take-up Rates, Private Industry Workers, March 2011, p. 193.

[3] Bureau of Labor Statistics, National Compensation Survey, Employee Benefits Survey, Table 2: Retirement Benefits: Access, Participation, and Take-up Rates, Private Industry Workers, March 2011, p. 382.

[4] North Dakota also offers a DC plan to non-classified state employees and elected officials.