New Jersey’s first step forward on pensions

In a nutshell, there are two types of pensions: defined benefit plans and defined contribution plans. The former give pension recipients a set amount per month, for life, based on a formula established while they are working. The latter, by contrast, are effectively savings accounts for employees to put aside some of their wages to cash out in retirement. Defined contribution systems—which the majority of Americans under 50 now have—are what the majority of private sector employers in the United States offer their employees.

Defined contribution pensions eliminate the risk to taxpayers, while giving ownership to workers. In a defined contribution plan, workers pay into a personal retirement fund that they draw down in retirement. Since workers own their own retirement accounts in a defined contribution plan, they don’t have to worry that a future legislature will curtail or manipulate benefits.

And defined contribution plans—like the 401(k)—give workers portability—retirement savings can be carried to another job. Defined benefit plans incentivize workers to stay put in order to collect a fixed pension, or to try to game the system by pole-vaulting to a higher-paying job for the last few years of their careers in order to pad their retirement payments.

Unfortunately, nobody has yet articulated a clear way for New Jersey to make such a move. But the state would not be traveling down a new road. Michigan moved to a defined contribution system in the 1990s.

That same decade the United States federal government began offering a defined contribution plan. In fact, New Jersey already offers a defined contribution plan—the Alternative Benefit Plan. But it’s only available for state university faculty and administrative staff.

New Jersey must stop piling more people onto a pyramid scheme where the base is unsustainable, and future benefits are no longer a sure bet. The only way to do that is to move public sector employees to a defined contribution pension system.

The Senate’s unanimous vote last month is a huge step in the right direction: it admits that New Jersey has a problem. But the prescription is far from complete. In order to fundamentally address New Jersey’s pension system—and by extension the state’s entire fiscal regime—officials in Trenton will have to look towards more sweeping and more lasting changes.

Daniel M. Rothschild is the managing director for the State and Local Policy Project at the Mercatus Center at George Mason University. Eileen Norcross is a senior research fellow and research director for the State and Local Policy Project at the Mercatus Center at George Mason University.