News Story

71 Percent Of New School Employees Choose 401(k) Over Pension

Employees themselves now on the hook for pension underfunding

When offered a choice between a traditional defined benefit pension and a 401(k) defined contribution retirement plan with substantial employer contributions, 71% of new Michigan school employees choose the 401(k). This despite the fact that defined benefit pensions have long been the rule in government workplaces.

The popularity of the 401(k) among these workers is related to the underfunding problem that eventually led lawmakers to close the old school pension system to new hires as of Feb. 1, 2018. That system had burdened Michigan taxpayers with $32.7 billion in unfunded liabilities.

So the lawmakers added a big catch to the pension option they included in a 2017 overhaul of the retirement system: Employees who choose it are themselves liable for future underfunding, not just taxpayers.

The new system was also adopted because years of past pension underfunding has put a significant strain on local school district budgets.

“The state accidentally made teachers the state’s largest creditor by underfunding the pension system,” said James Hohman, a fiscal policy analyst at the Mackinac Center for Public Policy.

Under the old defined-benefit system, state taxpayers were responsible for making up any pension funding shortfall. The new system splits any unfunded liability 50-50 between the state and those employees who choose the pension option.

It also makes the 401(k) defined contribution option the default for new school employees. This gives an automatic employer contribution of 4% of compensation to an employee’s tax deferred investment account. The state will then match an employee’s own contributions up to an additional 3% of compensation.

Responding to a Freedom of Information Act request from the Mackinac Center, the state budget office reported that 3,953 employees had selected the defined benefit pension as of Feb. 1, 2019. As of that first anniversary of the new system, most new school employees — 12,007 of them — instead chose the defined contribution system.

As of July 2019, 1,709 eligible employees were still in the election window.

This means 71% of new school employees were enrolled in the new defined contribution system, 21% opted for the traditional defined benefit system, and 8% were pending.