Home Retirement Rep. Kevin McCabe: Defined benefit, golden handcuffs, and HB 22’s hidden fiscal dangers for the future state budget

Rep. Kevin McCabe: Defined benefit, golden handcuffs, and HB 22’s hidden fiscal dangers for the future state budget

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With defined-contribution plans, employers promise to invest a certain amount of money each year. Defined contribution promises are short term, just a year at a time, and the employee is responsible for managing his or her account. 

A defined benefit plan, however, is a promise to employees to pay them a set amount, in retirement, no matter what the performance of the actual investment is. 

The problem with a defined benefit plan is that the amount an employee is guaranteed for retirement has little relation to what the employee puts in. The employee’s pension benefits are based on his or her final salary – which is often plussed up by overtime work at the end of a career – not on how much the employee contributed over his or her career.

We have all heard defined benefit employees saying. “Sorry, gotta work overtime, I am in my high three years.” 

With defined-benefit plans, employers also promise to top up the accounts if their investments don’t perform well enough to cover the agreed payouts. That is reassuring for employees. But what it all means to Alaskans, in aggregate, is that an employee earns far more in benefits than the employee ever contributed. Where is the money going to come from? The difference must be made up by the employer…. and what happens when the employer can no longer fund the plan? Do they shed it like a pair of dirty coveralls or turnout gear? 

Then who suffers? The 70-year-old retiree who can no longer get a job? The person who has worked for many years to get to the point where he can retire, who maybe has slowly used his savings and retirement for 10 years — who now has neither?

Personally, for me, I would rather have control of my own retirement than leave it for future legislators, bureaucrats, or a bankruptcy judge.

Consider, as well, that the top-ups may be needed years or even decades later. If an employee starts work for the state at 25 and retires at 65, his or her first pension check won’t arrive until 40 years after the first paycheck. That’s a very long-term promise, and it consequently presents some risks for employees.

The first risk is that the pension payout money might not be there when needed. Defined-benefit plans should pay retirees better than defined-contribution plans during economic downturns. But downturns are exactly when the state is least willing or able to top up their plan. Also consider that 40 years covers about 10 Senatorial and Governor election cycles and up to 20 House of Representative cycles. Will all those politicians and the bureaucrats they hire keep their predecessors’ promises through thick and thin?

Because they didn’t in Detroit. To squirm out of bankruptcy in 2014, Detroit politicians cut existing defined benefit pensions by almost 5% and eliminated other benefits entirely. Some benefit loss was even retroactive – retirees had to give money back as well as pay for health care plans. Could you afford a 5% decrease in your fixed income when inflation is headed above 10%?

In 2011, Rhode Island officials realized that they had saved only 56 per cent of the money needed to fund Rhode Island’s pension promises; Their defined benefit plan. To avoid disaster, they spent four years overhauling the state Defined Benefit plans. Retirees past and future lost some of their supposedly “defined” benefits.

The second risk with defined-benefit pensions is that employees (or their spouses) might not be there to receive them. The pension formulas typically set thresholds for calculating payments, based on age and/or years of service.  If you stick around long enough, you receive the full defined payout. The spousal benefit is typically an election; but what happens when both spouses pass away? In that case, the defined benefit money goes away. In a defined contribution scenario, however, the money in your account is yours and can be easily willed to your survivors. 

Defined benefit pensions are sometimes called “golden handcuffs.” They penalize people who switch employers too soon. Golden handcuffs refers to any benefits offered to an employee as an inducement to continue service. The meaning can be both positive and negative. In a positive spin, companies invest significant resources in the hiring and training of employees. In the negative, they may keep people around just waiting to meet some threshold or “high five” requirement.

Let’s face it, HB22 is designed handcuffs on police, EMS, and firefighters. It is designed to be an inducement to remain on the job. My question to Alaskans is this: Where is the money going to come from?

There will be public testimony on this bill in Community & Regional Affairs Committee at 8 am Tuesday, Jan. 31. You can testify on this bill through these methods:


Phone numbers:

  • From Juneau Prefixes: 586-9085
  • From Anchorage Prefixes 907-563-9085
  • All other Callers (Toll Free) 844-586-9085

Rep. Kevin McCabe serves in the Alaska House of Representatives for the Big Lake area.

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