By Eileen Norcross (George Mason University – Mercatus Center) & Andrew G. Biggs (American Enterprise Institute)

In this study, we consider the case of New Jersey, which operates five defined benefit pension plans for state employees. The New Jersey Senate unanimously passed legislation in February 2010 that would put a question on the November ballot to constitutionally require the state to begin to make its full annual payment to the state’s pension system. The bill requires the state to catch up to paying its full obligation by FY 2018. From that year forward the state will be constitutionally required to make the full payment to its pension systems each year as calculated by plan actuaries. The state reports that its pension systems are underfunded by $44.7 billion, when liabilities are discounted at the 8.25 percent annual return that New Jersey predicts it can achieve on funds’ investment portfolios. However, when plan liabilities are calculated in a manner consistent with private sector accounting requirements, methods that economists almost universally agree are more appropriate, New Jersey’s unfunded benefit obligation rises to $173.9 billion.

Given the costs and risks inherent in the defined benefit plan to taxpayers, as well as the political incentives for legislators to overpromise benefits to public sector workers while shirking on the state’s contributions, the state should close the current defined benefit plan to new workers and expand the existing defined contribution plans for all new state and local workers. Shifting employees to a defined contribution plan would ensure that New Jersey’s pension system for its public sector workforce is sustainable in the long term and reward younger workers with a guaranteed employer contribution to their individual retirement.

Source: SSRN