Arnold Schwarzenegger just proposed it for California. Michigan has had it since 1997. Florida has had an optional version since 2000. It’s time for New York to join the revolution and adopt the same kind of 401(k) retirement plan that is almost universal in the private sector for its future civil servants.

The idea may come as an initial shock to the unions, but in fact it would offer benefits to workers and taxpayers alike.

Over the last five years, New York City’s annual pension contribution for municipal workers has risen an incredible $2.6 billion. Another $700 million pension hike is expected in Mayor Bloomberg’s preliminary budget for fiscal 2006.

The problem is that the current public pension system is tailor-made to ensure that costs will rise most steeply when the city’s taxpayers can least afford it.

To make good on its pension promises to current and future retirees, the city has to maintain a large pension fund heavily reliant on investments whose value can fluctuate with market cycles. Fiscally speaking, a slumping stock market means the worst of all worlds for New York: Revenues will fall, and the required pension contribution will sharply rise.

To make matters worse, city and state politicians agreed to sweeten the public sector’s already lavish pension benefits in 2000 just as the market was peaking. (Nice timing, guys!)

Unfortunately, little can be done to curb these pension costs in the short term. But in the long run, New York can get out of the pension boom-and-bust cycle by shifting new government hires from the current defined-benefit plan to the kind of defined-contribution plan found throughout the private sector.

As its name implies, the defined-benefit plan provides city workers with a constitutionally guaranteed retirement benefit based on years of service and final average salary.

By contrast, under a defined-contribution�aka 401(k)�plan, an employer promises only to deposit a specific sum annually, usually a percentage of salary that matches worker contributions, into individual retirement accounts. The money in each worker’s account is managed by private firms and invested in a combination of stocks and bonds.

The size of the ultimate retirement benefit generated by such a plan depends on the amount of savings and investment returns a worker is able to accumulate. Both the downside risk of investment losses and the upside potential for investment gains are shifted from the employer�taxpayers�to the employee.

For decades now, a defined-contribution plan has been the retirement vehicle of choice for most employees of public higher education systems throughout the country, including the City University and State University of New York.

Even a comparatively generous defined-contribution plan would cap the average cost for new employees well below the double-digit percentage of salary the city must pay for current workers. Existing employees could stay in the old system, but the city’s pension costs would begin to drop sharply over the next 10 years due to the natural turnover as new employees join the new retirement system.

A 401(k)-style plan would be a much better deal for taxpayers. For the first time, the cost of city employee retirement benefits would be absolutely clear and predictable in the city budget.

Government workers would be eligible for retirement benefits comparable to those offered by the best private employers. And unlike current public pensions, those benefits would finally be portable from job to job�from public to private sector or vice versa.

The existing New York state and city pension funds, with literally hundreds of billions in investments, serve chiefly as enormous source of undue financial power for union bosses (and for the city and state controllers, who manage the funds). It’s high time we pulled the plug on this arrangement.

About the Author

E.J. McMahon

Edmund J. McMahon is Empire Center's founder and a senior fellow.

Read more by E.J. McMahon

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