A new Issue Brief published by the Center for Retirement Research (CRR) at Boston College sets out to test what it says is the conventional wisdom that all state and local government workers receive a lifetime annuity from their employer’s pension plan.
As explained by the brief’s authors, Jean-Pierre Aubry and Kevin Wandrei, both CRR research staffers, the new analysis investigates the extent to which this presumption is correct by examining the payout options offered by state and local plans, including those for the roughly 6.5 million employees who do not participate in Social Security. As Aubry and Wandrei note, these “noncovered” workers do not earn credit toward a Social Security annuity during their time in government, and thus they presumably need annuitized income from their employer plan more than their covered counterparts.
According to the brief, 88% of state and local workers—and 98% of noncovered workers—participate in a defined benefit (DB) pension plan, in which retirement benefits are presumed to be paid out as an annuity until death.
Within this annuity-first framework, the CRR brief identifies the four most common payout options as single-life annuities, joint-survivor life annuities, joint-survivor period certain annuities and a partial lump sum. The brief defines joint-survivor period certain annuities as annuities that guarantee survivor benefits for a specific period, often 10 years after the start of the retiree’s annuity. If the retiree dies within the guarantee period, the survivor receives an annuity for the remainder of the guarantee period only, but if the retiree dies after the guarantee period, payments cease, and the survivor receives no benefits.
Assessing these options, Aubry and Wandrei find that virtually all state and local workers are offered a single- and joint-life annuity, while about 40% are offered a period certain annuity and about 30% are offered a lump-sum option.
From this baseline, the brief examines what kind of payout state and local workers actually select upon retirement. At a high level, while the vast majority of state and local workers, both covered and noncovered, are in DB plans that offer a joint annuity, only about 43% of retirees choose this option. Aubry and Wandrei call this statistic interesting and even surprising, given the potential lack of Social Security spousal coverage for noncovered workers, whose take-up rate for this annuity type is about the same as for all workers.
Lump-sum payouts are offered by a total of 42 major state and local DB pension plans, covering 28% of all state and local workers and 49% of noncovered workers. As the CRR brief explains, most of these plans limit the lump-sum amount to 36 months of the retiree’s promised annuity payments, although a few plans allow up to 60 months. Aubry and Wandrei say the limits are meant to ensure that retirees who choose the lump sum still maintain a substantial portion of their annuitized benefits.
According to the brief, similar to government DB plans, the default payout option for public-sector cash balance plans, which currently cover just 3% of state and local workers, is an annuity. However, among public-sector defined contribution (DC) plans, which cover 9% of state and local workers, annuitization is never the default.
Aubry and Wandrei add that, because public-sector alternative plans are not yet fully mature, there is little useful data on the annuitization take-up rates. However, they say annuitization in the private sector could provide some insight, pointing to a recent study of TIAA participants showing only 18% chose an annuity distribution upon their first payout in 2018. The CRR brief says this is a stark drop from 2000 levels, but relatively constant since 2007, and, if members of public-sector DC plans annuitize at the same rate as TIAA members, that would equate to about 8%.
Taking all these numbers together, Aubry and Wandrei conclude that the there is a lot of truth in the presumption that state and local workers will receive a lifetime pension annuity in retirement from their government employer.
That said, the brief also concludes that it is important to remember a small share of all state and local workers (about 6%) do convert a portion of their pension annuity into a lump sum, and another 8% will potentially enter retirement with un-annuitized DC assets. Given that noncovered workers do not earn credit toward a Social Security annuity during their time in government, the few who retire without annuitized income from their state and local government retirement plan may find that they lack steady household income in retirement.
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