Writer: Staff Reports
The Institute of Government's Paula Sanford, an expert in local government finance, recently completed a public retirement study for the Center for State and Local Government Excellence (SLGE). This first national study of its kind explores how the practice of automatic escalation, gradually increasing employees' contributions to a defined contribution plan, can be used in the public sector.
Automatic escalation, common practice in the private sector, has a number of unique challenges in the public sector—perceived need, legal constraints, concerns over government paternalism, and limited employee financial flexibility. Sanford's study examined the use of plan features such as automatic escalation in defined contribution plans as a way to help ensure employees are better prepared for retirement.
Behavioral economics research has shown that decisions with outcomes far in the future are not based on a rational economic evaluation, and individuals may delay saving for retirement due to the complexity of the decision, limited self-control, and inertia. These obstacles, combined with a shift in financial responsibility as employees assume more responsibility for funding their retirements, demonstrate the importance of automatic features for retirement savings.
Since the 2008 economic downturn, states and local governments have continued to modify their retirement packages in an effort to offer their employees benefits that are fiscally sustainable and provide sufficient retirement income. Many of those modifications have focused on a shift in responsibility from employer to employees—defined benefit plans are less generous, requiring employees to save more.
Sanford used three case studies—Missouri, Ohio, and Virginia—to demonstrate the possible variations in designing an automatic escalation feature for a defined contribution plan. While each state differed in its approach, all shared the same primary goal of increasing employee savings.
"Because of wide differences among state and local governments and their retirement benefit packages, what works in one government may not work in another," said Sanford. "Being pragmatic and creative with automatic features, making enrollment and plan features easy to use, and focusing on communication and education all help ensure implementation success regardless of plan design."
Sanford's next SLGE report, due in June, explores auto-enrollment and addresses best practices in defined contribution plans and how best practices can be implemented in a public sector environment.