Vermont, New England facing state pension pressure

first_imgSource: Federal Reserve Bank of Boston, New England Public Policy Center. 6.30.2010. is external) Vermont and other New England states will face increasing pressure on pension plans as their populations get older and, consequently, they retire at an increasing rate. By 2030 in Vermont, 38 percent of the population will be 60 or older, the second highest in New England next to Maine’s 40 percent. The national average at that time will have climbed to 33 percent. Vermont and New England must come to terms financially with this phenomenon earlier than the rest of the US, according to a report released yesterday by the Federal Reserve Bank of Boston entitled: “Population Aging and State Pensions in New England.”One other factor noted in the report (LINK) that is also causing concern is the general effort by states to discourage state employees from working into their 60s. Because of extended life expectancies, pension payouts will be growing as people live longer. It will probably cost the states MORE by encouraging or even forcing early retirements at current pension levels.Over the next 20 years, the Census Bureau projects that the US population aged 65 and older will increase from 39 million to 71 million people, or by almost 80 percent, while the population under age 65 increases by just 12 percent. Among its many social and economic implications, population aging is placing financial pressure on the retirement programs that support older people in the United States, and indeed around the world. Many retirement plans are being reformed to address these financial pressures, and to reflect this changing age demographic. Also evolving are individual decisions about work and retirement in later life. These developments are interdependent. The age composition of the population, the design of financially sustainable retirement policies, and the evolution of labor market behavior at older ages are together in transition.Unlike most private-sector employers, all the New England states continue to offer traditional defined-benefit pension plans to state government employees. Under defined-benefit plans, an employee’s pension entitlement consists of a continuing salary-like payment stream through the post-retirement years. These benefits are paid for as long as the retiree lives, and, optionally, throughout the lifespan of his or her spouse or partner as well.1 Pension benefits are a significant part of the compensation package of most state employees. For long-service employees in particular, pension payments can be substantial, and the eligibility age for retirement young. For example:• A full-career employee hired at age 22 in Maine can retire at age 62 with a pension equal to 80 percent of her final salary (averaged over three years), adjusted for inflation every year, for as long as she lives. Life expectancy at age 62 is 19 more years for men and 22 more years for women. That means that a 40-year working career in state government in Maine buys, on average, a 20-year retirement at a benefit rate close to the worker’s full pre-retirement salary. • In Massachusetts, a worker hired in midcareer, at age 45, can still retire at age 65 with a pension that is 50 percent of his final average salary. If that employee was hired at age 33, his pension at age 65 would be 80 percent of his final average salary. Life expectancy at age 65 is 17 years for men and 20 years for women.• In Vermont, which reformed its pension plan in 2008, a new worker hired at age 27 will be able to retire at age 57 with a pension equal to 50 percent of the final average salary. And in Vermont, that pension is in addition to Social Security, rather than in place of it. Life expectancy at age 57 is 23 years for men and 27 years for women.Today’s financial pressure on state pension programs comes from many factors, including demographic change, increasing life expectancy, historical underfunding, recent investment losses, and strained economic conditions. Together, these factors have directed heightened attention to both the design of state pension benefits and their ongoing cost. In fact, pension reform is a growing focus of state policy discussions. Those discussions have led to the recent enactment of reforms in Massachusetts, Rhode Island, and Vermont, and to the appointment of study commissions in Maine, Massachusetts, and Vermont.The changing demographic environment is important to this discussion in two central ways, both of which motivate the descriptive analyses in this study. The first is the impact of increasing life expectancy. If the eligibility age for retirement benefits stays the same as people live longer, then the duration of retirement supported by state pension funds continually lengthens. Life expectancy at traditional retirement ages has risen by about four years since 1970, and shows no sign of slowing down. Thus a state worker retiring at age 62 today could expect to receive a pension for an average of 21 years of retirement. That raises the public policy question: What duration of later life should pension systems be structured to support? Perhaps more fundamentally: Should pension systems have a “normal” retirement age at all?Also central to the demographic context is the movement of the Baby Boom generation into the ages when people have traditionally retired. A critical macroeconomic question is how a proportionately smaller working-age population can support a proportionately larger population of retirees. Where will the work capacity come from to maintain the country’s aggregate economic production, or standard of living? Can the United States, New England, Massachusetts, or Rhode Island continue to produce as much output (and thus earn as much income) if a large wave of Baby Boomer retirement shrinks the relative size of the labor force?Proactive planning to address this latter question may present an economic opportunity for states that anticipate future labor force demographics. For those who are able, working longer seems a likely and economically beneficial corollary to demographic change. Because labor is the primary input to the economy’s productive capacity and income creation, states that facilitate continued work at older ages are likely to transition well into the emerging demographic environment. The implications for traditional pension plans are profound, because these plans typically contain strong financial incentives for employees to retire at or before the normal retirement ages indicated in the plans. The policy question is whether states want plans that induce retirement at specified ages, particularly young ages, or whether they want plans that are more age-neutral. Any pension plan can be redesigned to accommodate retirement at any age by eliminating the implicit financial penalty for working longer.This study aims to analyze the features of state pension plans in the context of this changing demographic environment. The focus is on the age-related characteristics of the plans. First, what retirement ages are indicated in the pension plan formulas, and how do they relate to current life expectancy? Second, to what extent do the benefit formulas penalize or reward continued work once an employee becomes eligible to receive pension benefits? And finally, how can states reform their pension plans to make them more ageneutral, or more accommodating toward continued work at older ages?The study compares the eligibility ages for benefits, the formulas used to determine benefits, the benefit adjustments made for those retiring earlier or later, and other key policy characteristics of the New England state pension plans.The study is organized into five sections. The first section describes the changing demographic environment in which pension plans operate. This section highlights the rapid growth of the older population in New England, resulting from both increasing life expectancy and the aging of the Baby Boom generation. The second section describes and compares key features of the primary state pension plan in each New England state, focusing in particular on the age-specific characteristics of the plans. The third section analyzes the labor market implications of the plans’ formulas, such as how they apply to workers choosing retirement at different ages.The fourth section focuses on program reform, including recently enacted reforms in New England states and alternative approaches to reform. The fifth section provides a brief conclusion. Finally, an appendix provides a more detailed state-by-state mapping of benefit- accrual patterns in the plans, based on illustrative employees hired at different ages.last_img

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