Texas Counties Set Example for Retirement
While it was already clear in the 1990s that the Social Security program would be facing serious financial problems, millions of state and local government workers outside of Social Security could boast that their government-provided retirement plans were doing just fine. No more. Now, most of those plans are in even worse shape than Social Security.
Government management of retirement assets has been an unmitigated disaster. The State of Illinois has an approximately $100 billion underfunded pension liability; New Jersey is looking at $47 billion gap; and California's state and local pensions are facing a $128 billion shortfall—which could grow to $327 billion if financial ratings service Moody's changes how it evaluates such plans, as it has proposed.
The city of Stockton, California, recently filed for Chapter 9 bankruptcy protection because it needs $900 million that it doesn't have to cover its pension obligations. And we will undoubtedly see many more such failures in the near future, as state and local governments rob from education and other state budgets, raise taxes or jiggle the books in an effort to fund (or hide) their massive unfunded pension obligations.
Government plans lack accountability for those in charge. Their mismanagement threatens recipients' benefits, and often leaves taxpayers on the hook. A plan to switch eligible state and local government workers into alternate plans which they, not the government, own, and which define contributions instead of promising specific benefits, is a critical step towards retirement security.
(Read More: Congress Returns to U.S. Public Pension Battle With New Bill)
The Government Accountability Office (GAO) estimates that about 30 percent of the 14.5 million full-time state and local government workers—e.g., teachers, firefighters, police, etc.—participate in local or state government retirement plans instead of Social Security. Most of those plans are, like Social Security, defined-benefit plans, in which the employer promises to pay retirees a fixed amount, based on some formula, for the rest of their lives.
However, most of those government defined-benefit plans assumed they would be making a rate of return on their investments that they haven't seen in a decade or more—leaving them dramatically underfunded. A 2012 study from the Federal Reserve Bank of Cleveland suggests that the largest 126 state and local pensions were underfunded by $800 billion in 2010, but concedes that some economists put that figure closer to $4 trillion.
But there are three Texas counties—Galveston, Brazoria and Matagorda—that aren't facing a retirement time bomb. That's because 30 years ago they decided to transition to a defined-contribution retirement plan for county workers that mirrored the payroll taxes and benefits of Social Security but avoided the long-term unfunded liabilities. Oh, and those workers have never lost a dime.
What's known as the "Alternate Plan" combines defined-contributions with employee ownership and downside investment protection. Employee and employer retirement contributions are pooled, like bank deposits in a savings account. While these funds are owned by the individual, they don't make investment decisions; that process is actively managed by a financial planner.
Top-rated financial institutions bid on the money, guaranteeing a base interest rate—usually about 3.75 percent—with a market-based performance kicker (i.e., the plan makes more money as the market goes up). Over the last decade, the accounts have earned between 3.75 percent and 5.75 percent every year, with an average of around 5 percent.
Thus, when the market goes up, employees can make more; however, when the market goes down, employees still make something, virtually eliminating the 401(k)/IRA problem of workers deciding not to retire because of a major drop in the market.
It's estimated that county workers who remain in the program their entire working lives will receive retirement benefits of about double what they would have gotten under Social Security, according the Alternate Plan's financial manager, First Financial Benefits of Houston. And even though employees don't make the investment decisions themselves, their money is in a personal account that belongs to them; so any funds left over become part of their estate at death and are not subject to the political whims of government officials.
Additionally, while Social Security provides a death benefit of $255, the Alternate Plan includes a life insurance policy that pays four times an employee's salary, up to $215,000.
State and local governments that operate outside of Social Security—there is no dropping out if they currently participate in it—can take the lead in fixing the pension problems that they have created by doing what those three Texas counties did 30 years ago: providing better benefits than Social Security without the long-term unfunded liabilities. This is an important first step in a process to shift retirement assets from government entities with no accountability or fiduciary responsibility in an effort to secure your financial future.
Carol Roth is a CNBC Contributor, the host of WGN radio's The Noon Show and bestselling author of The Entrepreneur Equation. Follow her onTwitter:
Merrill Matthews is a resident scholar at the Institute for Policy Innovation in Dallas, Texas. Follow him on Twitter: @MerrillMatthews.