State and local government retirement plans in the United States cover 14 million active employees (about 10 percent of the U.S. labor force) and 6 million retirees, including police officers, firefighters, legislators, judges, teachers and general employees. In 2003, state and local retirement plans had over $2 trillion in assets and paid annual benefits of $122 billion, averaging about $18,500 per retiree. Ninety percent of state and local governmental employees are covered by defined benefit retirement plans. Approximately 25 percent are not covered by Social Security, including close to half of public school teachers and three-quarters of police officers and firefighters.

Since the mid-1990s, legislation has been proposed in several states to replace state and local DB plans with DC plans. Over the last two years, the pace of these proposals has increased, due to downturns in the investment markets and resulting higher contribution rates for many DB plans. Proponents of the change argue that switching to a DC plan would lower the government’s cost of providing retirement benefits, thereby reducing state and local taxes. They also argue that DC plans would benefit public employees by giving them higher benefits through DC plan investment earnings and by making it easier for employees to take their benefits with them when they change jobs.

It is likely that switching to a DC plan would increase a government’s retirement costs over the short-term, and possibly over the long-term as well. In addition, recent studies indicate that retirement benefits provided though DC plans are, on average, significantly lower than those provided through DB plans. Moreover, while DC plans are useful for providing supplemental, tax-deferred retirement savings, replacing DB plans with DC plans could cause severe, unintended consequences:

• Governments could lose a valuable tool for attracting and retaining qualified employees;
  
  
• Public employees could lose a significant amount of retirement income, potentially affecting state and local economies; and
  
  
• Legislators could face additional pressure to increase DC retirement benefits and provide additional financial assistance for public sector retirees.