POLICY BRIEF FROM AMERICANS FOR TAX REFORM

Pension Liberation in Michigan

By: Peter J. Ferrara

Last December, Michigan became the first state in the Union to enact pension "liberation" for state employees. Under this reform, which passed both State Houses along almost straight party line votes, workers are able to take control of their share of pension funds in their own accounts, rather than leave them with the government.

As a result, workers will have the security and freedom of personal control over their own money. They don’t have to worry about politicians taking away their benefits or losing their funds. With control over their own money, they can get the high returns available in the private sector, and ultimately enjoy higher retirement benefits.

Moreover, workers will be assured that they will receive their benefits for the years they work. Michigan previously had a traditional defined benefit pension plan. Under such plans, workers are promised a certain benefit at retirement. The government keeps and invests the funds paid in during working years, to fund the promised benefits. But the plans are usually skewed so that long-term, career employees receive high benefits, while those who work fewer years receive little or nothing, despite the payments made into the plan for them. In effect, the funds of the short-term workers, are taken for the benefit of longer term workers. As a result, around 70% of state workers generally get nothing out of the retirement plan, and 10-20 percent get the benefit of their funds. For example, in Michigan’s old retirement plan, like many other traditional plans, the benefits did not 100% vest until the worker put in ten years of service. Under the new plan, however, benefits fully vest after four years.

The new Michigan plan is a defined contribution plan. The state employer pays the funds directly into each worker’s privately held account, which receives as well any payments from the worker. The worker then picks an investment manager to help plan and carry out the investments in the account. The worker consequently receives the pension payments as he works, and if he leaves, he takes his pension funds with him, regardless of how long he worked.

Moreover, because of the good returns that can be earned on private market investments, all workers will likely benefit from this reform, even long term workers. The private market returns will build up to huge amounts by retirement, probably even paying these long-term workers more in retirement than the old system.

All current employees in Michigan will now have the choice as to whether to stay in the old pension system. As a result, those who have worked under the old system for many years and believe it will be better for them can stay in it. But those who want freedom and control over their own money can choose the new option. All new employees hired in the future in Michigan will be in the new pension system.

Other states should follow Michigan as well in adopting pension liberation.