By Randall G. Holcombe, Ph.D.
Over the past few years both Governor Scott and several members of the Florida legislature have been pushing the idea of transforming the Florida Retirement System (FRS), which pays pensions to retired state workers, from a defined benefit system into a defined contribution system. A defined benefit system, which covers most state workers today, pays a specific monthly benefit determined by the number of years worked and the worker’s salary leading up to retirement. A defined contribution system pays a certain amount every year into an account owned by the employee, and the pension amount is determined by how much money the retiree’s account has accumulated in contributions and earnings on those contributions.
Defined benefit plans face the problem that governments can make promises to pay future pensions without setting aside the money to fund them. Eventually, the plans run out of money and can’t pay the promised pensions. Then, either the government must come up with more funding, or pensions must be cut, or some combination of the two. Defined contribution plans avoid this problem because the future pension is determined by the amount of money going in. That money is the property of the employee, and future government financial problems can’t erode retiree pensions. Defined contribution plans offer advantages to both employers and employees.
I agree that the state should shift FRS to defined contribution pensions, but really, the proposals from Governor Scott and reform-minded legislators do not go far enough. Many private investment firms are in the business of operating defined contribution pension plans. We should not only shift to defined contribution plans, but privatize those plans for new workers. The state does not need to operate a pension system because there are private sector firms who specialize in doing just that. Get the state out of the pension business altogether.