401(k) style plan safer than relying on Legislature

Gov. Henry McMaster wants to replace the defined-benefit retirement plan currently offered to state employees with a defined-contribution plan like the 401(k) programs offered by many private employers. As an economist and a retiree in the system, I support this recommendation.

First, some history: In 2012, the Legislature passed a law that was supposed to eliminate South Carolina’s $15 billion retirement shortfall by 2044. Then-Gov. Nikki Haley promised that while future state employees would contribute to the retirement fund at higher rates, current employees and retirees would get “what they were promised.”

Well, not really. Before 2012, retiree benefits were customarily adjusted to compensate for inflation. Under the 2012 reform, state retirees were guaranteed a 1 percent annual cost-of living increase — a guaranteed bad outcome. If inflation is more than 1 percent — and at the time it was projected to average 2.75 percent into the indefinite future — retirees would see the real (inflation-adjusted) value of their pensions decline steadily. A retiree suffering the misfortune of living 30 years in retirement would see the purchasing power of her annual pension benefit decline by 40 percent. That disappearing pension is not a gift bestowed by the state, but deferred compensation for services previously rendered.

Lawmakers would argue that because higher cost-of-living increases were not guaranteed, no promises were broken. However, paying pensions in depreciated dollars breaks a bond secured by custom, trust and goodwill.

Since 2012, inflation has been below the 2.75 percent forecast, so the damage hasn’t been as great as it could have been. But the retirement system needs another fix, and Gov. McMaster wants to cut the annual cost-of-living adjustment to zero. That is, he advocates breaking an explicit promise made to retirees just five years ago.

In an Aug. 15 letter, one state employee said, “I know I can rely on my defined-benefit pension” and it would be wrong to switch to “risky defined-contribution plans.” Regrettably, she is wrong. You cannot rely on a defined-benefit plan whose real purchasing power falls every year. And while defined-contribution plans have risks, over a lifetime the values of stocks and bonds in a 401(k) plan are likely to do better than keep up with inflation.